Approaching Retirement: How Do You Invest Your Money?

Experts agree on this:

Investment professionals agree that all investments can have times in which they are more “out of favor” than others. It is seldom possible to see these “out of favor” periods coming. Therefore, most investment managers agree that taking risk is unwise for shorter term “time horizons”, especially when it is known that a distribution or liquidation is likely to occur. As investors approach retirement, they may want to reduce risk as much as possible.

A primer on investing:

A traditional approach to minimizing risk is to mix “equity” type investments with “fixed income” type investments. Let’s first break down each of these types of investments.

“Equity” type investments typically refer to individual stocks, mutual funds or exchange traded funds (ETFs). Mutual funds or ETFs are often comprised of a hundred or more stocks of individual companies. A mutual fund or ETF that specifically tracks the performance of a stock index (like the S&P 500 index) can itself be comprised of hundreds of individual company stocks.
A stock in an individual company has both “stock risk” and “market risk”. “Stock risk” means that, if a company fails to achieve its earnings projections, loses market share, or has a change in management or the direction of the company, its stock may suddenly decline steeply in value. These types of issues may not affect other companies in that same industry or even the stock market in general.

“Market risk” typically means that, in purchasing equity type investments, when the stock market declines in value, many companies may experience losses in their stock price, even though that particular company did not itself experience any issues. In other words, investors can experience an overall decline in investment value due to circumstances which affect all or most companies.

Limiting the use of individual stocks and moving money into stock type mutual funds or ETFs is an excellent strategy for lowering stock risk in a person who is approaching retirement. It must be pointed out that, while there may be market risk reason to follow this strategy, there may also be other reasons not to do so, including but not limited to the tax implications of such a change. Before undertaking this strategy, one should consult with a tax professional and a financial advisor.

Another general investment category is called the “fixed income” type of investment. This refers to individual bonds, bond mutual funds or bond ETFs. Companies and governments often borrow money through the issuance and sale of bonds. When an investor buys a bond, or invests in a bond mutual fund or bond ETF, they are, in effect, participating in the lending of money to that entity.

Bond prices, as well as the value of shares in bond mutual funds and bond ETFs, are directly affected by interest rates. As interest rates rise, the price of bonds tends to fall – and vice versa. Bonds, bond mutual funds and bond ETFs tend to move in the opposite direction from equity type investments. While this is not always true, frequently this is the case. It can be understood from this that to lessen the volatility of the equity type investments mentioned above, balancing those investments with some bonds, bond mutual funds or bond ETFs may mitigate some risk.

Conventional approaches to minimizing risk

A commonly used approach to reduce risk is a 60/40 allocation – 60% of a portfolio would be comprised of equity type investments, while 40% would be comprised of bonds, bond mutual funds or bond ETFs.

Another common strategy is to make the bond-type exposure approximately equal the investor’s age, with the remaining percentage of invested funds in equity type investments. This approach tends to lower the volatility (price fluctuation) of the investment portfolio as the investor ages or approaches retirement, a time when many people are not in a position to take much risk.
A final conventional approach to minimizing risk is to move all or some portion of one’s investments into money market funds. Another low risk asset alternative is the use of US Government Treasury Notes or Certificates of Deposit (CDs). These type instruments are among the lowest risk type of investments. If an aging investor is extremely risk-averse, using money market funds or their equivalent could better serve their goals.

401(k) and 403(b) Withdrawals Rollovers

When a person leaves the employment of a company where a 401(k) or 403(b) investment is held in that person’s name, they typically then have the option to transfer the vested portion of money in their account into an IRA (or perhaps even a Roth IRA) in their own name. This type of transfer is called a “rollover”. When that money is transferred to an IRA, that account is called a Rollover IRA or Rollover Roth IRA. It is important to check with the plan or Plan Administrator for the details, because the ability to “roll” money out of a plan and into an IRA or Roth IRA is actually granted by the plan itself. For the purpose of this writing, differences or pros and cons of IRAs vs. Roth IRAs will not be discussed. If an individual is changing from one employer to another, it is also possible to “roll” the money over from one 401(k) or 403(b) plan with one employer to a similar plan with another employer, providing the plans allow that.

In-Service Withdrawals

A little known provision in 401(k) or 403(b) plans is called an “in-service withdrawal” provision. Investopedia defines an in-service withdrawal as “a withdrawal made from a qualified plan account before the holder experiences a triggering event. A triggering event, such as reaching a certain age, or leaving an employer, is often needed to be able to withdraw funds from a plan, such as a 401(k).”

This in-service withdrawal provision allows participants in 401(k) or 403(b) plans to “roll” their vested account balances over into their own IRA before they actually attain normal retirement age (but are over age 59 ½). This then allows the individual to have greater control of their investment account and to direct their investment options of these tax-favored dollars as they approach retirement.

For more information, see the following article.

Other considerations

As mentioned above, tax implications should be given careful consideration and can influence one’s decision to sell one asset and buy another, along with one’s personal risk tolerance. This is especially the case if one’s money is in a taxable account. Investments that are in IRAs, Roth IRAs, 401(k) and 403(b) plans are not affected by decisions to sell one type of investment within the plan and buy another.

Retirement investing: summary

While we can make no guarantees, we believe there are many ways to minimize or reduce risk as one approaches retirement. The first key is to take charge of your own money as much as possible. The second key is to get personalized and sound advice from multiple investment professionals. It is important to compare and contrast the level of risk being advised as retirement approaches.