You've been dutifully making your 401(k) contributions for a while now... but is your strategy really the best one for your needs? Here's a new way to look at things.
Don't panic: if you're making 401(k) contributions, you're far ahead of many of your peers when it comes to being ready for retirement. But beyond simply participating, there are various ways to invest to get more of what you need.
Wealth vs. Income
Many people choose a retirement planning strategy that invests for wealth. Sounds great, right, since who wouldn't want to chase wealth?
But there are different ways of looking at your investment performance. You can look at the size of your account: that's your wealth. Alternatively, you may also look at the income-generating potential of your investments. Some experts say that's actually more important than the size of your holdings!
The Target Date 401(k)
Over the past decade or so, the "Target Date" retirement account has become very popular. You choose your retirement date (that's your target date), and the financial institution managing your account adjusts your holdings according to how close you are to your target date.
That typically involves starting out with a heavy ratio of stocks to bonds, when you're young. The idea is to slowly move out of stocks as you get older, in order to minimize risk. Short-term bonds become a larger percentage of your portfolio, since they are less risky.
The idea is to keep your holdings steady- if the market dips, your account should remain relatively stable, not falling so much you can't recover in time to retire. This is known as a wealth strategy.
Consider the Income Strategy
An income strategy, on the other hand, would have your portfolio including annuities and long-term bonds, both of which are affected by long term interest rates. When you're trying not to let your holdings fall too far, this is considered a risky strategy, so those target date accounts usually shy away from these types of investments.
However, viewed from an income-generating point of view, long term bonds could be a good bet. That's because their prices run parallel to annuity prices, which would also be part of an income strategy of planning for retirement.
Watching your nest egg grow is a fun habit, but rather than focusing on the total amount, you might want to consider focusing instead on what sort of income that total can generate for you in retirement. Want more info? Ask your financial advisor, who can explain all this in terms easy for you to follow.
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Chris Hardy - CFP®, EA, ChFC®, CLU®,