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Asset allocation reduces volatility

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Taking on too much risk can also cause problems. Imagine this scenario: You're two years from retirement and you've got 90 percent of your portfolio in stocks. The stock market takes a sharp dive. Your nest egg shrinks accordingly and doesn't rebound in time for your retirement. You either take a big loss and risk outliving your savings or postpone retirement until the market rebounds.

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Other mistakes include not saving enough to meet your goals or raiding your retirement funds to put your children through college, Charney says.

Young people, in particular, should keep in mind that their retirement goal is so far off that a steep dip in the stock market is not a grave matter, and the performance of the market over the long haul outweighs any short-term risk. As you get older, you can manage risk by selling stocks and investing a larger portion of your portfolio in bonds or cash.

You also don't want to be chasing returns. Too often investors fall into that trap. "You want to be patient and not jump in and out of investments," says Bard Malovany of Sagemark Consulting.

Instead of buying a fund with blazing performance over the past six months or year, look for the best long-term fund for each investment category. It's important to note five- or 10-year performance numbers, but also look at the annual returns and compare them with that of the relevant benchmark (for stocks, that's usually the Standard & Poor's 500) to see if performance is erratic or fairly consistent. "You're not trying to find the best performer of all time. Instead, you're looking for the one that performs best compared with other funds in the same class," says Malovany.

Be sure you understand the composition of a particular fund before buying in. Don't just go by its name. A "balanced" fund may sound perfect, but you may find it is too conservative for your needs, Vanguard's Rinaldi says. Typically, balanced funds are split between equities, at 60 percent of assets, and bonds, at 40 percent, she says. Someone in their 20s needs a fund that is much more heavily weighted toward stocks. Even those in their early 40s should have around 90 percent invested in equities, she says. "You still have at least a 25-year run until retirement."

Also, if your company's contribution to retirement savings includes company stock, be sure it makes up no more than 10 percent of your portfolio, Rinaldi cautions. If it passes that 10 percent threshold, sell off some and invest the money elsewhere to ensure diversification.

 
 
Next: "Rebalancing your portfolio"
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NATIONAL OVERNIGHT AVERAGES
IRA MMA 0.51%
1 yr IRA CD 0.77%
5 yr IRA CD 1.85%
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