Money Girl answers listener questions and explains how to invest money in your retirement account, so you take the right amount of risk and reach your financial goals.
How Much Investment Risk Should I Take?
When considering how much investment risk you should take, keep in mind your retirement goal, the amount of time you have to achieve it, and your potential future income.
For instance, if you want to amass a huge nest egg, have a long time before you’ll need to spend it, and have steady income, you may want to invest more aggressively. If you have at least 10 years to go before retirement, you have plenty of time to recover from temporary market downturns along the way.
Consider this: If you invest $500 a month for 30 years at an average return of 3%, your balance will grow to about $250,000. Investing the same amount over 30 years at a 10% return would give you over $1.1 million, a difference of $850,000 to spend in retirement!
Now, I’m not encouraging you to take more risk than is absolutely necessary to reach your goal. However, in order to reach an expensive goal like retirement, you can’t invest too conservatively because you’re likely to fall short.
As you get closer to retirement, it’s wise to shift a larger percentage of your investments into less risky investments so you preserve your account and can get regular income from it. I’ll tell you how to do this in just a moment.
See also: 5 Best Investing Tips to Make More Money
How to Invest Money in Your IRA or 401k Retirement Account
Funds are simply a mix of individual investments (such as stocks and bonds), which can be designed to meet a variety of investment objectives. Funds give you built-in diversification, which is less risky than handpicking individual investments on your own.
In general, stocks are the riskiest investments because their value can change daily; however, they offer the highest returns. Bonds are less risky because they offer a fixed, but lower return. And cash or cash equivalents, such as money market funds, give you the lowest, but safest returns.
I recommend that you start by figuring out how much stock you should own. Here’s an easy shortcut: Subtract your age from 100 and use that number as the percentage of stock funds to own in your retirement portfolio.
For example, if you’re 40, you might consider holding 60% of your portfolio in stocks. If you tend to be more aggressive, subtract your age from 110 instead, which would indicate 70% for stocks. But this is just a rough guideline that you may decide to change.