"This is a little known fact for mainstream America," says John Pallaria, adjunct professor in the Certified Financial Planner program at Boston University, "but if they are under 59½ and tap a 401(k) or its equivalent to pay for education, they'll be hit with taxes and a 10 percent penalty on the amount of withdrawal."
Dipping into IRAs early is admissible in some circumstances, including education: "They can actually tap IRA products before 59½ and pay taxes but no penalty when using the funds for education," he says.
Invest for your time horizonDetermine your investment horizon to put your money in appropriate investments.
Short-term: For goals with a term of less than three years, you generally don't invest in the traditional sense. You save for them. For example, if you're saving for a down payment on a house, you'll want to put your money in a safe place that will be available when you're ready, without loss of principal. Consider six- or 12-month CDs, though you'll pay a penalty to access your money early; FDIC-insured high-interest-earning money market or savings accounts; low-cost money market mutual funds; or stable value funds. Find the best rates for these types of deposits on Bankrate's rate tables.
Intermediate-term: These goals are five to 10 years away. The key here is diversification. Look at keeping a small portion in higher-yielding money market accounts and CDs, and include Treasury securities, short-term to intermediate-term bonds or bond funds. If your timeline extends beyond five years, some equity exposure may be appropriate -- perhaps an index fund, which tends to be more tax-efficient than other funds, if this money is in a taxable account. Consider allocating a small portion to an international stock fund if you want to take on a little more risk.
Long-term: Depending on your risk tolerance, most people should be able to handle a bit more volatility in their portfolio; the alternative is to risk falling short of your goal. For goals beyond 10 years, a 70 percent allocation to equities might be appropriate because you'll need growth. Conservative investors nearing the 10-year mark may want to invest in a mixed stock and bond portfolio.
See examples of asset allocation charts in Bankrate's story, "Building a portfolio."
Determine your risk toleranceTry to keep out of investments that will keep you awake at night worrying about losses but expose yourself to enough risk so that your investments have the chance to grow.
"One thing people need to do is have a heart-to-heart with themselves," says John Pallaria, adjunct professor in the Certified Financial Planner program at Boston University. "How would they feel mentally if the $5,000 they invested Friday was only worth $4,200 on Monday? If they're uncomfortable with that, that's a red flag that they should consider the investment carefully and make sure it's a good fit."
Before you let yourself get too frightened off, be realistic. You have to be willing to assume risk if you want higher returns.
"Sometimes I hear people say, 'I don't want any volatility but I want to earn 8 percent.' It's impossible," Pallaria says.
Whether you're a DIY investor or are ready to run straight to the nearest financial adviser for help, it's important to assess your risk tolerance first. Even if you are a risk-taker in other areas of life, that same willingness to handle risk doesn't necessarily carry over to your financial life.
John Grable, professor in personal finance planning at Kansas State University cautions: "Don't just walk in thinking that the financial adviser will figure it out for you. Financial advisers come with different risk styles themselves." If you have the capacity to handle riskier investments and the stomach for it, a conservative adviser wouldn't be a good fit.
George Kinder, author of "Seven Stages of Money Maturity" and founder of the Kinder Institute of Life Planning says, "The thing with risk tolerance is, if you don't know what you're aiming for, it's very difficult to know how much risk you're willing to take. If you're aiming for the wrong thing, it's also difficult. If you're passionate about your aim, the amount of risk you're willing to take becomes very clear."
Still not sure how much you can stomach? Take this quiz to determine your risk tolerance.