July 11, 2011 in Retirement

5 tips for investment success

Take the controls

If you’ve left your company retirement plan on automatic pilot because you’re afraid to take the controls, you’re not alone. A September 2010 study by the Charles Schwab Corp. called “The New Rules of Engagement for 401(k) Success” found that only 47 percent of 401(k) participants feel “very confident” about making investment decisions.

Financial planner Jennifer Lane, founder and principal of Compass Planning Associates as well as author of “The Complete Idiot’s Guide to Protecting Your 401(k) and IRA,” says many people are so confused about what to do with their 401(k)s and other employer-provided plans that they ignore them altogether.

Instead of dodging decisions in hopes of coasting your way toward your retirement savings goal, follow these five tips to become a more confident, hands-on investor.

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Don’t settle for default contribution rates

Many employer retirement plans will automatically enroll you in a plan, typically at a contribution rate of 3 percent to 6 percent of your salary. That’s a good place to start if it at least equals the maximum rate your employer will match. But don’t get too comfortable at that level, or with the plan’s built-in increases.

Lane says most people need to save 10 percent to 15 percent of their income for retirement, and she notes that some financial planners tout 20 percent as the target amount.

Stuart Ritter, vice president and Certified Financial Planner with T. Rowe Price Investment Services in Baltimore, advocates saving 15 percent.

“If your employer is bringing you in at 6 percent and increasing you by 2 percent a year, it’s still going to be a number of years before you get to 15 percent,” Ritter says. “The sooner you get there, the better off you’re going to be.”

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Choose the asset allocation that fits you

One of the most important decisions you will make for your retirement plan is how to divide your investments among stock funds, bond funds and short-term investments such as money market or stable value funds. Your choice should be guided by your risk tolerance and the amount of time you have before you plan to retire.

“Using the target-date funds that a lot of 401(k)s have in them now is a good kind of cheat sheet,” Lane says. “You look at the target-date funds for your retirement age, pull up a chart on that fund and look at the volatility. Then you decide whether or not you’re willing to take that rough of a ride. If you’re not, then back down to a more conservative target-date fund.”

Even if you’re not investing in a target-date fund, you can follow its asset allocation formula as you design your own portfolio. Beth McHugh, vice president of market insights for Fidelity Investments in Boston, says that as long as you’re within 10 percent to 15 percent of the mark for your age group in each investment category, you’re generally in good shape.

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Bone up on investment styles

Need a little help figuring out what a particular fund may invest in? Lane recommends using Morningstar.com’s Style Box to analyze funds.

The Style Box is a nine-block grid designed to classify and aid in the evaluation of stock and bond funds. With a stock fund, for example, the vertical axis of the grid indicates the overall market capitalization of the fund, spanning from large companies at the top of the grid to small companies at the bottom. The horizontal axis of the grid shows the range of investment styles, from value at left to growth at right, and “blend” in the middle.

As an example, the Vanguard 500 Index Fund, which mimics the Standard & Poor’s 500 index, is a large-company fund containing fast-growing companies as well as mature companies that may pay a dividend. The grid of the fund’s Style Box is shaded across the top, indicating it’s a large-cap blend fund that holds value and growth companies.

Trying to choose an investment fund without understanding these basics can lead to trouble.

“Folks will chase performance and pick the fund that did the best, but they might not be comparing apples to apples,” Lane says. “They might be moving out of a small-cap into a large-cap fund, or vice versa.”

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Take the free advice

The Charles Schwab survey found that only 10 percent of 401(k) participants whose employers offered third-party investment advice as a benefit actually used the service. Of those who did take advantage of the offer, 70 percent made adjustments to their plans that nearly doubled their savings rates. Those who received professional guidance also had more diverse portfolios than those who did not.

Before you make an appointment with your company’s investment adviser — or seek one out on your own — do a little self-assessment. McHugh says you should be prepared to answer questions about how much you have saved — within your company retirement plan and elsewhere — as well as your expected retirement age and your anticipated retirement lifestyle.

Of course, you’ll want to get advice on your asset allocation, but Lane says you shouldn’t leave the choice entirely to the pros.

“If they make a recommendation, ask them why,” Lane says. “If they are just basing it on time frame and not the amount of volatility you’re willing to accept, really push back against that. You don’t want any cookie-cutter answers.”

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Take a critical view of financial news

The last thing you should do is make investment decisions or changes in your investment plan in response to the market swings reported in the news. Market volatility, especially in recent years, is enough to make even the most knowledgeable investor nervous. To prevent yourself from overreacting to any one bit of news, broaden your sources.

“If you read something you think is interesting, find another place where it’s written about, so that you can look at several different points of view,” Lane says.

McHugh says your best bet is to establish a plan and stick with it, no matter how wild the market roller coaster seems to be.

“You need to be comfortable in maintaining an age-appropriate asset allocation,” McHugh says. “If you do that and are able to almost look away, you’ll be able to recover.”

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