Sorry. You probably are not a dummy about everything. But, research suggests that almost 80 percent of all Americans have a very low financial IQ) So, the chances are high that you are a personal finance and investment dummy! And, good for you for doing something about it. (Maybe you aren’t a dummy at all. More people should follow your lead.)For those approaching retirement or already there, the question of how to invest your money to maximize returns while minimizing risk is at the heart of many of our financial concerns. With so much out of our control and so few clear answers, retirement investment questions can keep you up at night.
Here are a few of the most common issues and some suggestions for how to manage things to reduce stress.
1. Retirement investment for dummies: What are my options?
There are a lot of different ways to invest money for retirement. However, since this is retirement investments for dummies, let’s start with the basics: there are different types of accounts and different types of investments.
Accounts: You can save for retirement by stuffing money into the cookie jar or in a plain old savings account at your bank — often referred to as a cash account or anywhere really. However, to invest for retirement, you need to put your money in an investment account and it is usually better to save in a tax advantaged retirement account like a 401k or IRA.
Types of Investments: You can invest in almost anything. The best retirement investments for you will depend on your retirement timeline, needs and goals.
2. How Important is Investing to My Financial Well-Being?
Investing is one piece of the retirement puzzle, an important piece, but not everything.
Sometimes people think that saving and making the right investments is all they need to do. But, there are a lot of other considerations that, depending on your circumstances, have a more or less profound impact on your financial well-being. (Housing, taxes, expenses, when you start Social Security, how much you spend on healthcare and more might be more or less valuable to you than investments.)
However, making the right investments is actually one of the most straightforward ways to increase your wealth. You have lots of different options and not investing is actually akin to burning up your money — why not get returns on what you already have.
If you have money, make it work for you!
3. Is my money invested so that it will be there when I need it?
Figuring out how to align your investment portfolio with your necessary withdrawals might be the most important investing issue that retirees deal with. And, you are no dummy if you figure this out!
To do this, you need to know:
Your Retirement Spending: What do you need or want to spend for the rest of your life?
Beyond your day-to-day living expenses and thinking about how those will change over time, you also need to plan for anticipated major expenses such as purchasing a car, a major trip or any number of other big expenses. Plus figure out when debts will be paid off, what your out of pocket outlay will be for medical expenses and more…
Your Retirement Income: How much income you will have for the rest of your life? What will you collect from Social Security? Pension? Will you have a job for any period of time? Will you collect an inheritance? Downsize your home?
The Gap: What and when are there gaps between your spending and your income? These gaps will need to come from your savings.
Matching your fixed sources of income with your projected expenses will tell you how large of an income replacement gap you need to fill, in other words how much of your monthly and annual outlays will need to come from your investments in retirement and non-retirement accounts.
Sound overwhelming? Even smarty pants can feel defeated.
4. How do I allocate my portfolio? Do I have the right mix of investments?
Retirees have the competing goals of keeping ahead of inflation while not suffering undo losses when the market hits a rough patch. Your asset allocation should probably include some equities/stocks (though probably in the form of a fund for diversification reasons) to allow for growth with the rest in asset classes like bonds and others that are not subject to as much volatility.
What your allocation pie chart looks like will vary based upon your unique situation. A couple of options include:
1. The popular 60/40 (60% stocks to 40% fixed income). However, there really is no cookie cutter answer for asset allocation. This may or may not be the right answer for you.
2. The bucket approach is a more personalized option advocated by many retirement experts.
- In one bucket you maintain liquid assets — cash or other low risk investments in an amount to fund 1-3 years-worth of your retirement withdrawal needs. The reason for this bucket is to avoid the need to liquidate equities during periods when the stock market is down, realizing steep losses.
- The second bucket might contain up to five years-worth of living expenses and be invested in a combination of income producing investments and some that offer moderate growth opportunities. Bonds are an option for this bucket.
- The third and most aggressive bucket will be predominately invested in stocks or funds and more aggressive fixed and alternative type of investments. This bucket is designed for growth and to help you avoid running out of money by being too conservative.
The actual percentage allocation to each bucket will vary by household and how much you need and want to spend.
5. What do I need to do on an ongoing basis to keep my money safe?
What you need to do will depend on your goals and how your money is invested. You might want to consider drafting an Investment Policy Statement (IPS) on your own or with the help of a financial advisor. An IPS is a map for what to do when.
Just as with any stage of life, “set it and forget it” will not work for your retirement investing strategy.
- You will need to rebalance your portfolio to your target asset allocation periodically, generally at least annually.
- Market ups and downs can cause your portfolio to deviate from the target allocation leaving you with an allocation that takes too much or too little risk for your situation.
Beyond rebalancing your investment strategy will need ongoing monitoring, and potentially an update as well. An update in strategy may be needed in order to support your withdrawal needs or due to changes in your situation.
Flexibility is key watchword for investors during retirement.
6. Should I buy an annuity? Or, is it a scam?
Annuities can be a great way for those in or near retirement to stabilize a portion of their income. Some feel this is another leg on the retirement income stool along with Social Security, pensions and your various investment accounts. A lifetime annuity guarantees your income for life — no matter how long that turns out to be.
Annuities can be a solid way to insure income, but too often annuities are sold rather bought. Annuity contracts can be complex to read and understand, it is difficult for many investors to fully grasp the restrictions, underlying expenses and the surrender fees.
- If you are considering any annuity you really need to shop around. Beyond what is offered by those actively trying to sell you an annuity, look at low cost, no-load options like those offered by Vanguard and others.
- It is appropriate to ask how much you would receive in monthly income from several carriers and compare the answers. You will find that the payments may differ widely for the same annuitization option.
- Another key question is how much of your nest egg do you want to commit to an annuity?
Explore more of the pros and cons of annuities or get an instant annuity estimate. Find out how much income you could buy and see various options.
You might also want to explore other ways to produce retirement income.
7. What if I don’t need to make withdrawals?
For those of who are fortunate to have large fixed sources of retirement income from sources like a pension and/or Social Security, the amount that you need to withdraw from your retirement plans might be negligible. This will impact your investment strategy.
If your goal for this money is to grow it and leave a legacy for the next generation and perhaps to fund a charitable bequest, you can take a bit more risk with this money, depending upon your age and health.
While nobody can predict how long you will live, your age and time horizon will impact the level of investment risk you can take with this money.
8. Am I getting good advice from my financial advisor?
Good question! When you feel like you need a retirement investments for dummies guide, you probably aren’t confident in your ability to assess whether investment advice is useful or not.
And, frankly, you are not alone.
In a 2016 poll by the American Association of Individual Investors (AAII), only 2% of respondents claim to trust financial professionals “a lot.” While, 65% of respondents said they mistrust the financial services industry to some degree 15% say they trust them “a little.”
Here are a few things you can do to feel better about what your financial advisor tells you to do:
Ask Questions (Keep Asking Till You Understand): Ask questions about their recommendations! And, more importantly, make sure you understand the answers. Does your advisor explain things in a way that leaves you feeling confused? If the answer is yes, then you might not have the right advisor. The role of an advisor is to help you feel confident about your money.
Understand Compensation: Make sure that you understand exactly how your advisor is compensated. Ideally you use a fee only advisor. You are paying them for their time and expertise. A fee only advisor is working for you and only you. However, some advisors earn commissions on the products they sell you. Commissions are okay, but not if the advisor is selling you something you don’t need.
Try Out the Advice: Don’t blindly trust that your advisor knows what they are doing. Vet their advice.
For example, if an advisor to tell you that your future is secure if you buy a $50,000 annuity and invest $200,000 in a fund earning a 4% rate of return, try out that scenario with a do it yourself retirement planning tool.
9. What If the Stock Market Crashes? Inflation Skyrockets? My House Burns Down?
The unexpected can and will happen! And, the unexpected can have a profound effect on your retirement investments.
That’s why you want some back up plans and think through as many scenarios as possible.
Stock Market: The stock market is soaring — a little volatile at times, but still higher than it ever has been and this success is making some people nervous that a crash is coming. However, entirely avoiding exposure to stocks is not necessarily the best financial move.
Inflation: A retirement plan that doesn’t take inflation into account could meet the needs of retirees early in retirement but fail to meet their needs 10 to 15 years in.
House Burns Down and Everything Else: You don’t know what will happen, but you can set up your investments to protect your downside from common risks.
10. How do investments need to shift after I stop working?
Investing during retirement is equally or more important than the investment decisions you made during your working career while saving for retirement.
But, it is more complicated. You are taking money out of your accounts as you still try to maximize returns. And, you don’t want to run out.
There is no cookie-cutter approach for success. However, having a really detailed retirement plan, keeping it updated each quarter or year and making the necessary adjustments is one of the best things you can do.