As you work and save for retirement, you are in the accumulation phase of your financial life where the goal is to grow money. To achieve this goal, you likely utilized more than one kind of investment. Many different kinds of investment products exist such as: stocks, mutual funds, corporate and municipal bonds, bond mutual funds, lifecycle funds, exchange-traded funds (ETFs), money market funds, and U.S. Treasury securities.
As the time of retirement nears, you enter into the distribution phase of your financial life where the goal is to distribute the dollars you have saved. As retirement approaches, it’s important to take a look at your current portfolio to make sure it is aligned with your current investment goals.
Here is a closer look at the three most common investment choices with an eye for how they could impact someone at or nearing retirement:
- Stocks: Out of all the investment choices, stocks have the best track record for the highest rewards, however, that also comes with the highest amount of risk. When you buy a stock or equity, you become a “stockholder,” which means you own a share of a particular company. A company issues stocks to pay off debt, expand, or launch new products. There are generally two kinds of stocks: common and preferred, which can fall into one or more of four categories: growth stocks, income stocks, value stocks, and blue-chip stocks. Sometimes employees are offered stock benefits as part of their retirement benefit package.
TIP: When you have all or the majority of your money in one stock, you risk losing all or the majority of your money should that stock fail. Investors who have stock options should meet with a qualified financial expert before retiring in order to determine suitable diversification strategies.
- Bonds: You might think of a bond as a classic “IOU.” When you purchase a bond, you are basically lending money to the issuer, which is usually a company, municipality, or even a government. In return, the issuer promises two things: (1) they will pay you a certain interest rate during the life of the bond and (2) they will give you back the full amount of your principal when the bond matures. The benefit of this during retirement is principal protection; the downside is that bonds are generally long-term investments with lower interest rates that take 20 or more years to mature. If you need your money before the bond matures, then you could assume the risk of loss. Another risk is that there are different kinds of bonds. Bonds with higher return rates and shorter time lines come with higher risk. High-yield bonds, junk-bonds, and bond funds, for example, offer returns similar to stocks and as such, they carry higher risk.
TIP: Many investors who hold bond funds don’t realize that their investment can still go down in value. This could be problematic for retirees who are relying on their portfolios for their income needs. Bond funds, which are a collection of multiple bonds, may carry higher risk than regular bonds and investors should be aware of these five main differences: (1) Bond funds do NOT offer principal protection. (2) Bond funds DO have ongoing fees and expenses that eat directly into your returns. (3) Bond funds do NOT have a maturity date. The exception is bond Unit Investment Trusts. (4) The interest rate on bond funds can change. (5.) Bond funds can usually be sold at any time, unlike regular bonds that have a maturity date or could take longer to sell.
- Mutual funds are an easy way for investors to diversify among stocks, bonds, and short-term debt. A mutual fund by definition is a company that pulls together money from multiple investors with the purpose of investing in multiple securities. The big “pie” of the mutual fund is its portfolio, and as the investor, your “slice” of the portfolio is represented by the number of shares you buy into the fund. Whereas investing in only one or two company stocks can invite dramatic losses should that particular company loose, mutual funds are an easy and affordable way for the average investor to get a managed portfolio that is diversified. Mutual funds invest in different things such as stocks, bonds, and money market funds often described as cash equivalents. The saying, “don’t put all your eggs in one basket” speaks to the mutual fund theory of diversification.
TIP: Investors who are at or nearing retirement need to be aware that a mutual fund is still a market correlated investment, which means that if the stock market does poorly, you could lose a significant portion of your nest egg. Almost 70 percent of all investors lost money in the market during 2015 because they took on a lot of risk and held a lot of cash.
If you want to know more about how to better diversify your portfolio for the goal of a long and secure retirement, please contact us and one of our financial experts will get back to you.