Retirement funds: Decide what to buy
The difference between an account and an investment
When you choose an account, you're deciding how you want the money in the account to be treated.
For example, an IRA has certain rules about how much money you can put in every year and the kind of tax breaks you get.
A taxable account has different rules—mostly about how the money you earn in the account is taxed.
But an account isn't what you're actually buying. It's just a place to hold your investments. There are many types of investments—and thousands of mutual funds, ETFs (exchange-traded funds), and individual stocks, CDs, and bonds you could consider—but choosing among your retirement investment options doesn't have to be difficult.
In fact, investing for retirement can be as easy as figuring out when you think you might retire.
IRA (individual retirement account)
A type of account created by the IRS that offers tax benefits when you use it to save for retirement.
Accounts that don't receive special tax treatment, so all interest, dividends, and capital gains are subject to taxation in the year they're received.
An asset—like a mutual fund, ETF (exchange-traded fund), stock, bond, or CD (certificate of deposit)—purchased in the hope that it will increase in price or pay income
A type of investment that pools shareholder money and invests it in a variety of securities. Each investor owns shares of the fund and can buy or sell these shares at any time. Mutual funds are typically more diversified, low-cost, and convenient than investing in individual securities, and they're professionally managed.
ETF (exchange-traded fund)
An ETF combines the diversification and professional management of a mutual fund with the trading flexibility and intraday pricing of an individual stock.
The first step in picking investments: Your asset mix
When saving for retirement, you'll make some decisions that have a big impact on the final amount you have for retirement:
- When you start saving.
- How much you save each year.
But there's also a third factor you might not have thought about:
- The mix of assets you hold.
Why is asset mix important?
The way your account is divided among different asset classes, including stock, bond, and short-term or "cash" investments.
Usually refers to investment risk, which is a measure of how likely it is that you could lose money in an investment. However, there are other types of risk when it comes to investing.
The profit you get from investing money. Over time, this profit is based mainly on the amount of risk associated with the investment. So, for example, less-risky investments like certificates of deposit (CDs) or savings accounts generally earn a low rate of return, and higher-risk investments like stocks generally earn a higher rate of return.
What's the best asset mix?
That depends on how far away you are from retirement. If you've got 40 years left, you should focus less on the risk of short-term losses and more on maximizing the growth you can expect over the long term.
As you get closer to retirement, however, you'll want to lower your risk of losses (while still earning more than the rate of inflation).
Target-date funds: A modern approach for today's investors
Target-date funds are designed to:
- Identify the mixes of stocks and bonds that offer an appropriate balance between risk and return at every stage of retirement investing.
- Adjust your mix for you as you get closer to retirement.
So, for example, if you think you'll retire in about 40 years, you could choose a target-date fund for people retiring in 2055.
The fund will start out weighted much more heavily in stocks and transition over the next 40 years to a heavier weighting in less-risky assets, and potentially inflation-protected securities as well.
Because these funds are managed for you:
- You won't need to spend time selecting retirement investments that align with your chosen asset mix.
- You won't need to remember to rebalance back to your intended mix when market movements veer you off course.
- You'll lessen the chance of throwing your strategy off course by tinkering with your investment choices in the future.
A mutual fund intended for retirement savers that automatically rebalances and adjusts its asset mix as investors get closer to retirement. For example, a 20-year-old might invest in a target-date fund for people planning to retire around 2060. Target-date funds are professionally managed and typically diversified across asset classes and market segments.
A type of fixed income investment that pays a rate of interest that increases and decreases based on the rate of inflation.
To move money in your account so that your overall portfolio aligns with the asset mix you selected, usually after market movements have caused it to change.
What do others do?
Most employer-sponsored retirement plans (401(k)s, for example) use target-date funds as the "default" investment for newly enrolled participants. It's a great option if you're not sure what to choose.
Source: Vanguard, How America Saves 2018. This study examined employer retirement plans (and their participants) managed by Vanguard.
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All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss.
Investments in Target Retirement Funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. The fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in a Target Retirement Fund is not guaranteed at any time, including on or after the target date.