Asset allocation reduces volatility
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.
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,"
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
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.