retirement

Weighing risk vs. return

Retirement » Basics » Weighing Risk Vs. Return

You might have seen "Man vs. Wild," the TV show about surviving in the wilderness on roots, berries and available wildlife while fending off predators.

It's not unlike investing for retirement.

OK, you're not risking personal safety with your retirement portfolio. But consider: Any investment carries some inherent risk.

For example, the money you've plowed into stocks could evaporate like a tropical shower if your investments tank.

But if you think you hedge against danger by filling your portfolio with so-called safe choices such as Treasuries, CDs and cash -- think again. These investments have lower yields, meaning there's a bigger chance that inflation can erode their gains and leave you short.

"The less risk you take on, the more likely you are to fail meeting long-term goals," says John Markese, former president of the American Association of Individual Investors.

Trouble is, it's the riskier investments -- whether they be high-yield junk bonds or stocks -- that have the potential to make you the most money.

How to shield yourself against tough market forces:

  • Diversify. Buy an array of investments instead of entrusting your money (and future) into just a single investment, be it company stock, a single industry or one particular geographical area. Mix things up by investing in various assets. Mutual funds are among the cheapest ways to do this.
  • Get help. If you're not sure what to do, ask someone who knows more. Call your human resources department, or better yet, call the investment firm directly to get some guidance.
  • Take the easy route. Consider buying target-date mutual funds. They'll keep you on track to meeting goals by automatically allocating the underlying assets according to your age, with funds getting more conservative as time passes.
  • Take a long view. Sure the market's a bumpy ride, but don't let it throw you off balance. "For most investors, short-term volatility is irrelevant if they have a long-term horizon of five years or more," says Markese.

Playing it too safe may already be a pitfall for many younger individuals, according to a recent study by UBS. It found that adults age 21 to 36 -- Gen Y -- are the most fiscally conservative of any generation since the Great Depression, with 52 percent of their portfolios, on average, dedicated to cash.

Ignoring expenses is another pitfall. What may sound small, such as a difference of a percentage point or two, can add up to huge losses down the road. For example, if you save $3,000 annually and assets grow 8.5 percent a year on average, you'd have $555,233 after 35 years if you pay 0.18 percent in fees. You'd only have $423,863 if fees were 1.40 percent.

But the greatest risk of all is doing nothing -- or not enough -- to prepare for retirement.

The trick is to balance risk against reward. And that's where risk tolerance enters the picture. If you don't develop the thick skin of a survivalist, you may undermine your efforts to hit a savings target, depending on your age and financial goals. For instance, let's say you want to retire early, but losing even a fraction of your money throws you into a panic. If that's the case, you need to either reset your goals or take a bigger dose of courage to hit savings targets.

The good news? You can take some steps to protect yourself.

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