Earning a good return on your retirement investments is important. And to do that, you typically need to invest at least some of your money in the stock market.
For some Americans, however, too much of their money is invested in stocks. A Fidelity survey showed that around 23.1% of people saving money in a 401(k) are invested in a higher percentage of equities than recommended. This includes 7% of 401(k) investors, who have 100% of their money in the market.
While investors of all ages are overinvested in stocks, this is particularly common among baby boomers. Among people in this demographic, 37.6% have too much money invested in equities, including 7.9% who have all of their money in stocks.
Why is it risky to be overinvested in equities?
Maintaining the proper asset allocation is essential to balance risk. If you invest too little money in the market, it will be difficult to earn reasonable returns, and you must invest a lot more to amass the wealth you need to see you through retirement. But if you invest too much in the market, you take a chance on incurring big losses, at least in the short term.
When you're younger, you can afford to take on more risk and invest more in stocks because you have more time for your investment portfolio to bounce back if it performs poorly. But as you get older and nearer to the time when you have to start drawing from your retirement savings accounts, you can't necessarily afford to wait out market downturns if you have too much in stocks.
That's why retirees should have far less of their money in equities than a 20-year-old. Young investors will go through lots of boom-and-bust cycles in the market. But since they aren't planning on taking out money for decades, it doesn't matter a whole lot if they incur some short-term losses. A retiree who needs to take out money this year, next year, and every year for the foreseeable future can't afford to just leave money invested until the market recovers from a downturn.
How much of your portfolio should you have invested in stocks?
If you don't want to be among the quarter of Americans invested in a portfolio that's too risky, you need to make a conscious choice about how much of your money should be in stocks versus safer investments such as bonds.
For most investors, the best approach is to subtract their age from 110. Using this approach, a 20-year-old would invest 90% of a portfolio in equities, and a 70-year-old would have 40% of it in the market.
Since the percentage of your portfolio that should be in equities gets a little smaller each year, you need to actively manage your 401(k) and other accounts to make sure you reallocate your assets periodically. Checking in once a year is a good idea, if you aren't making changes more often than that.
Be smart about how your assets are allocated
Some investors may decide they want 100% of their retirement accounts in the market, even though that approach is riskier. Others may decide to buy less than the recommended amount of stocks because they are more risk averse, even if that means they have to put more money away.
The important thing is to make a conscious choice. Just don't invest your money in your 401(k) and forget it. You can pick a target-date fund that rebalances your portfolio for you as you age based on when you plan to retire. Or you can be proactive yourself in making sure you have the right mix of investment products to meet your current and future needs.