While economists and stock gurus spend this month making forecasts, ordinary investors are faced with the challenge of figuring out how to allocate their 401(k), IRA and other retirement accounts.
To do that well, you don't need a crystal ball to forecast either economic growth or market results. What you do need is an understanding of how various assets work, the self-discipline to override your emotions, and the patience to take the long-run perspective when everyone else is focused on the yearly outlook.
Here are five things you need to remember as you deal with your long-term investments:
--Your time horizon is personal: A retirement account is, by definition, a personal investment. If you're under 50, you have the advantage of knowing that history says you will make money in the stock market over time. There has never been a 20-year period that resulted in a loss in the S&P 500, if you reinvested dividends in your tax-sheltered retirement account.
If you're nearing retirement, you have the certain knowledge that in a few years you won't be able to contribute more money to take advantage of market declines — and you'll be required to withdraw. But because your lifespan is likely to be at least 20 years after you retire, you always need some stock market exposure.
--Keep it simple: Don't be intimidated by the challenges of choosing investments. You achieve total exposure to the U.S. stock market through a S&P 500 stock index fund in your retirement account or IRA. Not only do you get a diversified stock investment, but the fees are the lowest with an index fund. That should be your base investment, and at least 50 percent of your stock market exposure, before considering other stock funds.
--Rebalancing is essential: Even though you invest for the long run, you can't just “set it and forget it” when it comes to deciding how your retirement plan should be allocated. The start of the year is the perfect time to rebalance. You likely made stock market profits last year since your S&P 500 stock index fund posted a 12 percent return in 2016, including dividends. Should you move some to other investments?
The challenge is in choosing alternatives when you rebalance. Younger investors can stick with their major allocation to stocks, despite the gains. But those nearing or in retirement need to consider liquidity for required withdrawals.
--Understand the risks of the alternatives: Inside most 401(k) plans you'll find only the traditional alternatives of stock funds, bond funds and money market equivalents. When you're worried that you have too much invested in stocks, the instinct is to switch to “safer” bond funds. But bonds have risks similar to stocks. When interest rates rise, bond prices fall! So you could be “out of the frying pan and into the fire” if you switch to a bond fund to protect yourself from stock losses.
As an alternative, if your retirement plan offers a “balanced fund” then you can let the portfolio manager decide on the best mix of stocks and bonds. Or an “equity-income fund” manager can try to get you the best yield, while minimizing the risk of price declines.
--Save outside your retirement plan: There is no law that says all retirement savings have to be made inside a tax-sheltered plan. Some investment alternatives, ranging from money markets to real estate to collectibles are best done outside a retirement plan, where you can take advantage of certain tax breaks on both carrying costs and profits. So be sure to look at the big picture. If there isn't enough diversification within your plan, save more outside your plan.
Patience is the greatest virtue in investing. Just ask Warren Buffett, who is famously patient. Sadly, by the time most investors learn this lesson, they have run out of time to put it to good use. And that's The Savage Truth.
Terry Savage is a registered investment adviser and the author of four best-selling books, including “The Savage Truth on Money.” She responds to questions on her blog at TerrySavage.com.