What to invest in: choose your investments
Guide to retirement planning
This article is part of NerdWallet’s plain language guide on how to build, grow, and manage your money.
Now you know how and where to save for retirement, and the difference between investing and saving. We have reviewed some of our favorite types of investments and praised the stock market on several occasions.
In fact, after reading Chapter 3, you might think that we get a bribe every time someone invests in the stock market. We don’t. While we firmly believe that the majority of your retirement savings should be invested in the market, a good portfolio is balanced between stocks and bonds.
You need stocks for their strong growth and bonds for their steady income and low volatility. (What about cryptocurrencies and other alternative assets, you ask? Very good. But use your fictitious money, not your retirement savings, for these speculative ventures.)
In this chapter, we’ll help you decide what to invest in – how to allocate your money between stocks and bonds – and show you how to choose specific investments. If that doesn’t appeal to you, stick around anyway – we also have information on how to hire a pro to help you out, for less.
Decide how much money to invest where
A rule of thumb for deciding where to invest your money and how to divide your portfolio between stocks and bonds is to subtract your age from 100 and put the result – as a percentage of your pot of money – in stocks. So if you are 30, you will invest 70% in stocks and the rest in bonds.
Unfortunately, the ground rules are not perfect. Some experts say investors in their 30s should put nearly 80% of their retirement savings in stocks. In other words, subtract your age from 110 and invest that amount in stocks.
Another way to dig a little deeper into the best asset allocation for you is to answer these two questions:
1. How long until you need the money?
We discussed this in Chapter 1. It’s the same concept, but more specifically your expected retirement age and how many years you have left before you reach it.
If your answer is “Not until I retire in 20 years”, then hello, stock market. This time frame gives you time to digest the ups and downs of the market and profit from the bounty of the stock market over time.
As you approach retirement, you’ll want to consider transferring part of your portfolio to cash, such as a savings account, money market account, or certificate of deposit. You’ll be in that five-year zone that we talked about in Chapter 1, and you’ll want to make sure that the money you will need to dip into for your living expenses in the first few years of your retirement will be available to you even if the market is going through a period of downturn.
2. How risk averse are you?
When the stock market crashes, what will your reaction be? If you can sit back and focus on the long term, even if you watch your investments temporarily decimated, you are a good candidate to invest 80% or 90% in stocks.
But if your reaction to a market downturn is to take your money and run away, go for a less volatile investment portfolio. You’ll be forgoing some potential gains, but if you’re more likely to stick with that portfolio through the ups and downs, it’s worth it.
Investors who continued to invest in stocks even during the 2008-09 stock market crash found themselves 10 years later with account balances roughly 50% higher than people who sold stocks during the recession, according to one study of around 1.5 million people in occupational retirement. plans administered by Fidelity Investments.
If you’re not sure how you would react to a market downturn, we have a risk tolerance quiz at the bottom of the page to help you find out.
Choose your own investments …
So now you know you want to invest, say, 80% of your money in stocks and 20% in bonds. If you want to build your own retirement investment portfolio, your next decision is which stocks and bonds, in particular, to invest in. (If you’d really prefer not to go into these details, there’s no shame in getting help with stuff like this. Below, we’re talking about inexpensive ways to get expert advice. )
Investing for retirement is not that complicated. You can build an incredibly diverse retirement portfolio by investing in just three mutual funds:
A mutual fund that invests in the entire US stock market.
A mutual fund that invests across the entire international stock market.
A mutual fund that invests across the entire US bond market.
These mutual funds will let you invest in thousands of companies and hold a wide variety of bonds, and they can fuel your retirement savings for decades.
Keep in mind that mutual funds have different names, depending on the provider. What you will see in your 401 (k) or at your brokerage house may vary. For example, to invest in the entire US stock market, there is Vanguard’s Total Stock Market Index Fund, Fidelity’s Total Market Index Fund, or Schwab’s Total Stock Market Index Fund – and those are just three of the choices. so many others.
If you invest through a brokerage house, you will have no trouble finding a total US stock fund, an international fund, and a total US bond fund. Your 401 (k), however, may have fewer options. If you don’t see funds that look like these three types, consider a target date fund. We discuss maturity funds in more detail below.
Each fund will have its own web page – either on your 401 (k) website or on the fund provider’s website – where you can see what their strategy is (for example, investing in the entire US stock market).
This page is also where you can view the fund’s expenses – and you definitely want to look at the expenses. Focus on the expense ratio: this is the cost of the fund as a percentage of the amount you invested in that fund.
Note that the expense ratio for the same mutual fund can vary, depending on whether you are investing via a 401 (k) or not, and how much money you are investing, so you should check the expense ratio for that particular fund. using the link found in your 401 (k) or brokerage account.
Ideally, you invest in index mutual funds. As we mentioned in Chapter 3, they track an index that includes many companies, as opposed to actively managed funds, where a live human selects the underlying investments for the fund. Index funds are generally less expensive. Look for mutual funds with an expense ratio of less than 0.5%, if possible.
… or find a pro to help you
There is an alternative to choosing your own investments: Hire a professional investor to do it for you, at a lower cost.
If you are investing as part of your 401 (k) plan or some other type of work plan, a target date fund can be a great option for a no-go investment. Target date funds are created by investment professionals and are designed to invest in a diverse group of mutual funds on your behalf, with a mix of US stocks and international bonds, similar to what we described above.
These funds are named based on a retirement year, such as the XYZ 2050 Target Date Fund, and you choose the fund whose year is the date you plan to retire. As you approach your retirement date, the fund mix automatically adjusts to be less dynamic / volatile than it was when retirement was far away (although many target date funds assume you will continue to invest throughout retirement keeping you at least partially invested in stocks well beyond your retirement year).
You always need to make sure you’re not overpaying: For comparison, the target date mutual funds offered by Vanguard, one of the cheapest providers, have a weighted average expense ratio of around 0, 13%, according to Morningstar. Research. If the target date funds available in your 401 (k) charge significantly more than that, you have three options:
Invest just enough to get your match, then start contributing to an IRA.
Build your own fund portfolio, like the three fund portfolio example above. You can do it, we promise.
Get professional advice on your 401 (k) through Blooom, a company that will give away your 401 (k) investment choices for free once, including ideas for improvement. (There is a charge for ongoing maintenance. See our Bloom reviews to know more.)
If you invest outside of a work plan, you can get investment management through a digital advisor (also called a robo-advisor), such as Betterment or Wealthfront, or through an app like Acorns or Stash.
Many robot advisers don’t have an account minimum, so you can start with $ 10 or even less. The cheapest robo-advisers charge a fee of 0.25% of your account balance.
You will complete a questionnaire to give the robot advisor an idea of your risk tolerance and how long you plan to invest. This, in turn, helps him choose the best investments for you.
That’s it! Whether you choose your own investments or hire a professional to help you out, now you can cross “invest for retirement” from your to-do list.
You don’t know how you would react in the event of a slowdown? Our quick quiz will help you get a feel for your risk tolerance.