Pension Financial Services

Four Things Every Retirement Investor Should Know replacing How a 401k plan works

Charles Schwab & Company recently suggested the following four things every retirement investor should know.

1. Contribute the maximum you can

Make the most of a company retirement plan: Investing in a company 401(k) or other retirement program is a powerful savings tools. 401(k) deductions are pre-tax and, money can grow tax-deferred. Investors should contribute the maximum amount for the greatest benefit, or at the very least, set aside the percentage the employer matches. Matching dollars are also pre-tax, which can greatly increase growth potential over time.

Maximize opportunities with previous employers' plans: If a 401(k) is still with a former employer, investors may want to consider rolling over a 401(k) into an IRA for greater investment choice and control, and to help protect the retirement assets that have accumulated.

2. Be aware of risk

All investments contain some degree of risk, but there are ways to minimize it. The main types of risk that can affect a portfolio are:

Inflation risk: Also known as purchasing power risk, inflation risk is the possibility that the value of investments will not keep pace with continually rising prices of standard goods and services.
Market risk: Also known as principal risk, market risk is the chance that investment value may decline and even cause a loss to a principal investment.
Interest rate risk: Interest rate risk is the risk that the value of a fixed-rate investment will change as market interest rates change. For example, the value of a Treasury bill or bond may decline if interest rates rise. Conversely, its value could increase if rates fall.

When choosing investments, investors should structure portfolios to minimize risk. The following may lead to increased portfolio risk:

Equity concentration: If just a few stocks comprise a significant portion of holdings, the portfolio may be at risk for increased volatility. Often, investors may not be aware that equity mutual funds also contribute to this risk. For example, if an investor owns shares of an individual large-cap stock and owns a large-cap mutual fund that invests in the same stock, the overall portfolio becomes more susceptible to the movements of that stock's price. Schwab advises diversifying retirement plans so that any individual stock holding -- individually, or across mutual funds - represents no more than 20 to 30 percent of a portfolio.
Sector concentration: When stocks in a particular industry or related groups of industries constitute a large part of retirement plan holdings, the portfolio might face greater volatility. For example, if a portfolio consists of many shares of stocks and mutual funds representing the health care industry, it will be more vulnerable to price fluctuations caused by events within the industry. Schwab advises diversifying a portfolio so that concentration in an individual sector does not exceed that of the market (represented by the Wilshire 5000 Index) by more than 20 percentage points.

Two investment strategies that may help minimize your risk are diversification and dollar cost averaging.

Diversification: Diversification simply means selecting investments from different investment categories to reduce exposure to risk. So rather than risk your money on the success or failure of a single investment, you combine a variety of holdings such as individual stocks, bonds, and mutual funds, which are unlikely to all move in the same direction.
Dollar cost averaging: Dollar cost averaging means investing an equal amount of money in a group of investments at regular intervals. When prices are lower, your money buys more shares of the investment. When prices are higher, your money buys fewer shares.

3. Save beyond company retirement plans

Generally, most Americans will need 70 to 80 percent of their current income in order to sustain a comfortable lifestyle during their retirement years. Unfortunately, Social Security will not be enough for most. In addition to company retirement plans, the following retirement savings vehicles may help investors achieve financial independence in retirement:

IRAs: Due to recent tax changes, IRA contribution limits are increasing significantly.⁽¹⁾ In 2005, the maximum IRA contribution is $4,000. Plus, additional catch-up contributions may be available for investors age 50 and over. You have a choice of traditional or Roth IRAs, both of which offer tax-deferred growth. Your eligibility to participate and deduct contributions may depend on your income, tax filing status, and company retirement plan participation.⁽²⁾
Annuities: Annuities provide the opportunity for additional tax-deferred savings with no annual contribution limits. And unlike other retirement savings plans, required withdrawals need not begin until well after age 70 1/2.⁽³⁾ Annuities are best used as a long-term investment tool (at least 7-10 years), and are best suited for investors in higher income brackets.

4. Plan and re-evaluate a retirement investment strategy

Whether retirement is in five years or 20 years, investors should periodically re-evaluate retirement portfolio and assess progress toward retirement goals.

Stay on track: Schwab advises that investors review their portfolio at least once a year, and certainly whenever personal circumstances change. Typically, investors can evaluate the performance of investments against relevant risk-adjusted benchmarks, and, when necessary, re-balance their portfolio to stay on track with your long-term financial plan.
Become a lifelong investor: Investing for growth should not necessarily stop at retirement. To keep investments working throughout retirement, investors may want to keep a portion of their portfolio invested for growth, rather than automatically shifting all of money into fixed-income and money market investments too early.

(1) Consult your tax advisor to determine if your situation allows higher contributions.
(2) Distributions made before age 59 1/2 may be subject to early withdrawal penalties.
(3) Withdrawals of earnings are subject to ordinary income tax.

Information provided in partnership with 401khelpcenter.com, LLC. 401khelpcenter.com, LLC is not the author of the material unless specifically noted. We do not endorse and disclaims any and all responsibility or liability for the accuracy, content, completeness, legality, or reliability of the material.
Copyright (c) 2005 by 401khelpcenter.com, LLC. All rights reserved.
THIS ARTICLE IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND IS NOT INTENDED AS LEGAL,TAX OR INVESTMENT ADVICE.