September 28, 2015
Your employer-sponsored retirement savings plan is a convenient way to help you accumulate money for retirement. Using payroll deductions, you invest for the future automatically, following that oft-noted advice to "pay yourself first." But choosing to participate is just one important step. Another key to making it work for you is managing risk in your portfolio for retirement. Following are five ways to tackle this important task.
Gauging your personal risk tolerance--or your ability to endure losses in your account due to swings in the market--is an important first step. All investments come with some level of risk, so it's important to be aware of how much volatility you can comfortably withstand before choosing investments.
One way to do this is to reflect on a series of questions, such as:
- How would you react knowing the value of your retirement portfolio dropped 5%? 10%? 20%?
- How much time do you have until you will need the money? Typically, the longer your time horizon, the more you may be able to hold steady during short-term downturns in pursuit of longer-term goals.
- Do you have savings and investments outside of your plan, including an emergency savings account?
2. Develop a target asset allocation
Once you understand your risk tolerance, the next step is to develop an asset allocation mix that is suitable for your retirement savings goal while taking your risk tolerance into consideration. Asset allocation is the process of dividing your investment dollars among the various asset categories offered in your plan, generally stocks, bonds, and cash/stable value investments. If you're a young investor with a hardy tolerance for risk, you might choose an allocation composed heavily of stocks. On the other hand, if retirement is less than 10 years away and you fear losing money, your allocation might lean more toward bonds and cash investments, which provide less opportunity for capital appreciation, but provide more stability in value.
3. Be sure to diversify
Even the most aggressive investor can potentially benefit from diversification, which generally means not putting all your money in one type of investment. Let's take one example from above: Although that young investor may choose to put a large chunk of her retirement account in stocks, she should still consider putting some of the money into bonds and possibly cash to help ease losses and take advantage of recoveries in the stock market. Even within the stock allocation, she may want to diversify among different types of stocks, such as domestic, international, growth, and value stocks.
4. Understand dollar cost averaging (DCA)
When you contribute to a retirement plan at work, chances are you contribute an equal dollar amount each pay period, which then purchases shares of the investments you have selected. This process--investing a fixed dollar amount at regular intervals--is DCA. As the prices of the investments you purchase rise and fall over time, you take advantage of the swings by buying fewer shares when prices are high and more shares when prices are low--in essence, following the old investing adage to "buy low." After a period of time, the average cost you pay for the shares you accumulate may be lower than if you had purchased all the shares with one lump sum. DCA encourages you to continue investing in down markets, and thus, reduces the average price per share you’ve purchased.
5. Perform regular maintenance
During the reviews of your retirement plans, determine if your risk tolerance or time horizon has changed and check your asset allocation to determine whether it's still on track. You may want to make other changes in your portfolio to keep it in line with your circumstances. Such regular maintenance is critical to help manage risk in your portfolio.
HCM monitors your managed accounts on an ongoing basis, and performs active account maintenance, such tactically reducing risk in our Advance and Defend™ Portfolios and rebalancing in our Strategic Portfolios. If you would like help with the account maintenance for your plan at work, please talk to your Wealth Advisor at the Cincinnati firm of Hengehold Capital Management.
Original content written by Broadridge Investor Communication Solutions and all edits are done with permission. Content in this article is not intended to be financial advice. Instead, we think of it as educational, and financial education is important to us.