Retirement Investing: Less May Not Be More

Not all investing is alike. This is especially true when it comes to preparing for retirement, where the stakes are more complicated than buy low/sell high.

From real estate to the stock market, retirement investing brings its own set of risks, parameters and generally accepted guidelines. This isn’t about quick profits, it’ s more about long term performance, which means near term issues such as liquidity (ease of getting to your money if you need it) and risk become more complicated than with regular investing.

And the stakes – how you spend your retirement years – make doing your homework worth the effort.

The Time-Risk Relationship

In the stock market, history shows a rather symmetrical history of strength and weakness, sometimes taking years to evolve from phase to phase. Which means that if you’re young, you may choose to accept the inevitable valleys the market will experience over the years in anticipation of an overall upward slope on the net worth of your portfolio.

The risk is to try to time the market and pull out at the highs and jump back in at the lows. Statistics show that investors who stick it out over the long term do better, and with significantly lower risk than market players who try to beat the market by timing it.

The closer you are to retirement age, however, the more you should pay attention to both risk and liquidity. Risk is a function of the state of the economy in general, and the market in particular, during the years that remain until you need to pull your money out of the market to finance your retirement.

Which means, it may not be a good idea to invest in startups and high risk mid-cap companies, or even stocks in general, when safer bond and debt instruments are available at lower levels of risk, yet with acceptable returns.

Taking Advantage of Retirement Programs

Unlike other forms of investing, there are safe and very common retirement programs that allow investors to take advantage of tax incentives and employer-enhanced overall returns.

There are two primary vehicles that give retirement funds a step up over traditional investment vehicles: the 401K, and the IRA. They’re simple to understand, but you still need to know this terrain to make the best decisions for your situation.

Welcome to your 401K

A 401K is a program offered by many employers that allows employees to invest a certain percentage of their gross pay (up to 15%) in a tax-sheltered investment program. The investments usually include various risk-level choices among mutual funds, allowing the employee to observe the time-to-risk ratio – the closer to retirement you are, the less risk you may be willing to take, and vice versa.

The real advantage of the 401K, however, comes when the employer has a program for contributing matching funds. This is a dollar-for-dollar additional contribution to the investment account paid by the employer, up to a maximum of 6% of the employee’s gross pay (not all employers match to that maximum level). This, in effect, greatly enhances the overall return on the employee’s invested money, and over time reaps significant benefits, including hedging against down markets.

Hey, it’s your IRA!

An IRA is a program in which an individual (acting separately from any company or organization) can contribute money to a tax sheltered account, which earns money within that account over time on a tax-deferred basis. This means that any money earned on the account – interest, profits on sales of securities, etc. – is not taxed until the money is withdrawn.

Withdrawal from an IRA must begin after the participant turns age 59 ½, and all money must be withdrawn before reaching the age of 69 ½. There are penalties on early withdrawals, and because the funds were not taxed at the time of investing, they become fully taxable upon withdrawal, the theory being that the tax rate will be lower for individual than during their higher career-earning years.

Withdrawals on 401K money follows generally the same rules, and may include penalties for early withdrawal, including forfeiture of matching funds. In the case of 401K money, deposted money has not been taxed and does not appear as taxable income on the employee’s withholding form. In the case of IRA contributions, the money is deducted from taxable income on the tax return for that year.

All investors should consult their tax professional for specific guidelines about both of these programs. Also, qualified investment professionals can help you determine the best options and risk levels for your age, your goals and your specific retirement needs.

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