Retirement Investing Explained
Al Waller: Do you have a grasp of retirement investing? Do you understand the terminology? If you do, then you are among the relatively few. A recent survey from nonprofit Transamerica Institute found that almost two-thirds of U.S. workers say they do not know as much as they should about retirement investing.
Welcome back to ClearPath – Your Roadmap to Health & Wealth SM. I’m your host, Al Waller. Joining me is Catherine Collinson, founding CEO and president of Transamerica Institute® and its Transamerica Center for Retirement Studies®. On this episode, she’ll discuss survey findings and share insights from her team’s research. Importantly, she’ll share an overview of four key concepts of retirement investing.
Before we get started, I want to remind our listeners that we would love to hear from you and get to know what topics you’d like to hear about. Please drop us a line at [email protected].
Catherine, in this day and age, it’s concerning that so many workers lack knowledge about retirement investing, especially given that most are counting on 401(k) or similar plans to be a main source of funding for their future retirement.
Catherine Collinson: Yes, it is concerning, and that is why I’m eager to explain four key concepts of retirement investing on today’s episode. These four concepts include asset allocation, diversification, rebalancing, and professionally managed services. In explaining them, I’ll be drawing heavily from the U.S. Securities and Exchange Commission’s – or SEC’s – investor education website. They do a terrific job distilling complex topics into understandable everyday language. And I’ll also be referring to our own research.
Al, if you’re ready, I’d like to take each of these concepts one at a time.
Al Waller: That sounds like a good approach to me. Let’s start with the first concept, asset allocation.
Catherine Collinson: Asset allocation is fundamental to retirement investing, but only 13% of workers indicate they know “a great deal” about it, according to our survey findings. So, it is the perfect starting point for our conversation.
Asset allocation involves dividing an investment portfolio – for example a 401(k) account – among different asset categories, such as stocks, bonds, and cash. The process of determining which mix of assets in a portfolio is a very personal choice depending on your risk tolerance and your time horizon to save and invest before you retire.
A younger worker with a longer time horizon to retirement may feel more comfortable taking on riskier, or more volatile, investments because they can have more time to ride the inevitable ups and downs of the financial markets. Whereas an older worker who is nearing retirement would likely take on less risk because they have a shorter time horizon to weather any storm.
Al Waller: The idea of a time horizon seems pretty straightforward to me, but I’m hoping you can explain more about risk tolerance.
Catherine Collinson: Risk tolerance is one’s ability and willingness to lose some or all of your original investment in exchange for greater potential returns. An aggressive investor, or someone with a high-risk tolerance, is more likely to risk potentially losing money in order to get better results.
A conservative investor, or one with a low-risk tolerance, tends to favor investments that will preserve their original investment.
Risk tolerance is a matter of personal preference and, importantly, one’s overall financial situation and ability to withstand potential losses.
Al Waller: What makes asset allocation so important for retirement investing?
Catherine Collinson: Asset allocation could help protect against significant losses. Historically, the returns of the three major asset categories – stocks, bonds, and cash -- have not moved up and down at the same time. Market conditions that cause one asset category to do well often cause another asset category to have average or poor returns. By investing in more than one asset category, you’ll reduce the risk that you’ll lose money, and your portfolio’s overall investment returns will have a smoother ride. If one asset category’s investment return falls, you’ll be in a position to counteract your losses in that asset category with better investment returns in another asset category.
Al Waller: Thank you for clearing this up. The second concept you mentioned is diversification. What is it?
Catherine Collinson: To put it simply, diversification is not putting all your eggs in one basket. Diversification is the practice of spreading money among different investments to reduce risk. By picking the right group of investments, you may be able to limit your losses and reduce the fluctuations of specific investment returns without sacrificing too much potential gain.
Al Waller: For me, diversification sounds similar to asset allocation. How is it different?
Catherine Collinson: That’s a good question and my sense is that a lot of people may be asking it, too. Asset allocation is about having the appropriate level of risk in one’s portfolio that could help them achieve their long-term retirement savings goals.
If you don’t include enough risk in your portfolio, your investments may not earn a large enough return to meet your goal. When saving for a long-term goal, such as retirement, most financial experts agree that you will likely need to include at least some stock or stock investment funds in your portfolio. On the other hand, if you include too much risk in your portfolio, the money for your goal may not be there when you need it.
Diversification tells us, “Don’t put all your eggs in one basket.” It involves spreading your savings across investments in the hope that if one investment loses money, the other investments will more than make up for those losses.
Al Waller: Now that you’ve cleared that up for me. How does someone go about figuring out what asset allocation is right for them?
Catherine Collinson: Al, this is the tricky part because there’s so much at stake. You’re trying to pick a mix of assets that has the highest probability of meeting your goal at a level of risk you can live with.
Thankfully, for those saving in a 401(k) or similar plan, this is an area in which your employer’s retirement plan provider can be of assistance. Retirement plan providers offer a variety of services and resources that can help you determine an appropriate asset allocation mix based on your situation.
You could also consider using a professional financial advisor. If you go this route, be sure to do a thorough check of their credentials.
For those interested in learning more and possibly taking a do-it-yourself approach, it’s important to study up on asset categories and investments by reading books, learning from experts, and even taking classes and doing coursework.
Al Waller: When and how often should people change their asset allocation?
Catherine Collinson: The most common reason is a change in your time horizon. In saving for retirement, you would gradually change your asset allocation as you get older. Most people hold less stock and more bonds and cash equivalents as they approach retirement. You may also need to change your asset allocation if there is a change in your risk tolerance, financial situation, or the financial goal itself.
Savvy investors typically do not change their asset allocation based on the relative performance of asset categories - for example, increasing the proportion of stocks in one’s portfolio when the stock market is hot. Instead, that’s when they “rebalance” their portfolios.
Al Waller: Ahh, that leads to the third concept that you plan to discuss. What is rebalancing?
Catherine Collinson: Rebalancing is bringing your portfolio back to your original asset allocation mix. For example, you may find that some of your investments will grow faster over time than others. By rebalancing, you’ll ensure that your portfolio does not overemphasize one or more asset categories, and you’ll return your portfolio to a comfortable level of risk.
When you rebalance, you’ll need to review the investments within each asset allocation category. If any of these investments are out of alignment with your goals, you’ll need to make changes to bring them back to their original allocation within the asset category.
Before you rebalance your portfolio, you should consider whether the method of rebalancing you decide to use will trigger transaction fees or potential tax consequences. Your retirement plan provider, financial professional, or tax adviser can help you identify ways that you can minimize these potential costs.
Al Waller: When and how often should people rebalance?
Catherine Collinson: You can rebalance your portfolio based either on the calendar or on your investments. Many financial experts recommend that investors rebalance their portfolios on a regular time interval, such as every six or twelve months. The advantage of this method is that the calendar is a reminder of when you should consider rebalancing.
Others recommend rebalancing only when the relative weight of an asset class increases or decreases more than a certain percentage that you’ve identified in advance. The advantage of this method is that your investments tell you when to rebalance. In either case, rebalancing tends to work best when done on a relatively infrequent basis.
Al Waller: For me, this all sounds like it’s not for the faint of heart. I imagine there are do-it-yourself investors out there, but I’m not one of them.
Catherine Collinson: Al, you’re not alone. Our survey found that 67% of workers would like to receive more information and advice from their employers on how to reach their retirement goals, and 57% would prefer to rely on outside experts to monitor and manage their retirement savings.
Al Waller: What solutions are available that can help with this?
Catherine Collinson: The fourth and final concept is professionally managed services.
In the context of 401(k) or similar plans, professionally managed services have become ubiquitous. These services are designed to enable plan participants to invest in ways that are aligned with their goals, years to retirement, and/or risk tolerance profile.
Our employer survey found that more than nine in 10 retirement plan sponsors (94%) offer at least one of the following services:
- A managed account service that makes investment or allocation decisions for participants.
- Model portfolios that use the funds in the plan lineup to meet a participant’s retirement date and/or risk tolerance profile.
- Target date funds that are designed to change allocation percentages for participants as they approach their target retirement year.
- Target risk funds that are designed to address participants’ specific risk tolerance profiles.
It’s important to be on the lookout for what is available and learn about what may work best for you. When evaluating your options, be sure to understand how they work and any potential costs involved.
Al Waller: Thank you, Catherine, for your insights. I’ve learned a lot and I hope our listeners have, too. Where can people go to learn more?
Catherine Collinson: Earlier in the podcast, I mentioned the SEC’s investor education which can be found at www.sec.gov. Specifically, I have been referencing its Beginner’s Guide to Asset Allocation, Diversification, and Rebalancing.
Additionally, FINRA—the Financial Industry Regulatory Authority – has extensive investor education and insights available on its website. It also has BrokerCheck which is a free tool to research the background and experience of financial brokers, advisers, and firms. Visit www.finra.org.
Lastly, if you’re interested in Transamerica Institute’s research including the report that we’ve referenced, Stepping Into the Future: Employers, Workers, and the Multigenerational Workforce, please visit our website at www.transamericainstitute.org.
Al Waller: Thanks, Catherine, for this enlightening conversation. Until our next episode, stay safe, be well, and thanks for listening.
ClearPath – Your Roadmap to Health & Wealth is brought to you by Transamerica Institute, a nonprofit private foundation dedicated to identifying, researching, and educating the public about retirement security and the intersections of health and financial well-being.
You can find our weekly podcast on WYPR’s website and mobile app, wherever you get your podcasts, and at transamericainstitute.org/podcast.
ClearPath – Your Roadmap to Health & Wealth is produced by the Transamerica Institute with assistance from WYPR.
The information provided here is for educational purposes only and should not be construed as insurance, securities, ERISA, tax, investment, legal, medical, or financial advice or guidance. Asset allocation and diversification do not assure or guarantee better performance, cannot eliminate the risk of investment losses, and do not protect against an overall declining market.
