Today, many Americans are feeling nervous about opening the envelope containing their 401(k) or IRA statements. No matter what type of assets you hold in your 401(k) or IRA, more than likely they have fallen in value during the past year. That is why it is important to allocate your assets in a variety of investment types.
“Many people who were approaching retirement did not change their asset allocation and, as a result, the performance in their 401(k) plan was poor,” says Mark F. Rhein, senior vice president of The Private Bank at Fifth Third Bank, Tampa Bay. “They’re now questioning whether they’ll be able to retire or have to continue working.”
Smart Business learned more from Rhein about how asset allocation can lessen investors’ overall portfolio risk.
How does asset allocation help to mitigate investment risk?
Investing in broad groups, such as stocks, bonds, commodities and real estate investment trusts (REITs), may have lower risk than putting all funds in one asset type. Generally, one of these investment types is going up in value or holding its value, when others may be going down in value during a business cycle. That is the basis of diversification. Investors then trim gains and reinvest the proceeds periodically to take advantage of varying price moves for the long-term betterment of their portfolios.
What should investors remember in this environment?
We have heard from many clients saying they have lost sleep because of their 401(k) or IRA accounts. The assets to help them retire five, 10 or 20 years down the road are now worth substantially less. In an attempt to recoup some of the value of their assets, they reallocate often in reaction to the markets and hope for the best. However, that type of ‘trading on emotion’ is one of the most common mistakes individual investors can make during this time. Investors will try anything to stop the hemorrhaging in their 401(k) or IRA. Unfortunately, there is no quick fix in restoring confidence to financial markets, which has been eroding over the past two years. Patience is truly a virtue during a period of contraction.
They should be asking themselves, ‘What are my long-term goals and objectives? Are they still the same? If they are, what is happening with the market as it relates to its impact on my IRA and 401(k)? What does that mean in terms of how I should change my overall strategy?’ As people get closer to retirement, they should be looking at their asset allocation and reducing some of the risk.
What can investors do right now?
Now is the time to go back to the basics with your 401(k) or IRA account. Given the stress of the financial market, it is advisable to take another look at your overall financial plan and how your 401(k) or IRA fits in to it.
- Step back and look at your time horizon. When do you want to retire? With
your 401(k) or IRA losses, will you have
to add another three, four or five years to that horizon in order for your assets to
rise in value?
- Look at your risk tolerance. How
much are you willing to risk? If you are up
at night fretting about how much you have
invested, you are risking too much. Seek
to comfort yourself mentally by incrementally shifting your asset allocation.
- Look at your asset allocation ranges.
A conservative rule of thumb is to hold
your age in fixed-income securities. For
example, a 40-year-old should invest 60
percent in equities and 40 percent in fixed
income. Conversely, a 60-year-old should
invest 40 percent in equities and 60 percent in fixed income. This is only a general guideline; a different allocation may
better suit your specific situation.
- Have a deliberate rebalancing approach in mind. At Fifth Third Private Bank, we are finding most people are falling into two categories: trading just to trade or not trading at all. Seek to rebalance your portfolio on a semiannual or annual basis to instill discipline in your investment decisions and take advantage of the benefits of diversification.
What else should investors know?
Do not hesitate to ask for advice. A qualified financial planner/professional should give individual investors professional, unbiased assistance that will help them through business and investment cycles. We believe the next few years will likely see a reincarnation of the markets and the financial system, and a wealth management adviser should be able to help you make the most of it.
Once again, these financial times are extremely unique. Being deliberate and incremental in decisions involving asset allocation will help individual investors sleep a little easier during turbulent market conditions.
MARK F. RHEIN is senior vice president of The Private Bank at Fifth Third Bank, Tampa Bay. Reach him at (813) 306-2492 or email@example.com.