3 Critical Retirement Investing Tips for Beginners

Have you thought about beginning to invest for your retirement, only to be daunted by the thought of how complex investing feels?

Well, it’s early in the New Year, so this is a great time to make a resolution to have 2014 be the year you learn how to invest successfully for the long-term.

Here are three critical retirement investing suggestions for the beginner investor.

#1: Understand The Meaning of “Investing”

The word itself can be intimidating. For some reason, many people who are perfectly comfortable with the word “savings” get all queasy with the word “investment.” Is there really a difference? Yes, but it’s not a scary one.

“Savings” and “investment” both mean deferring today’s income for a future purpose. In other words, it starts from having a goal you want to accomplish down the road, plus recognition that reaching your goal means putting money aside.

“Investing” means that in addition to saving your money, you’re also creating a strategy that is aligned with your goal. This strategy takes into account the rate at which your money needs to grow, as well as how comfortable you are with the possibility of experiencing short-term losses along the way.

That’s it. Investing is nothing more than identifying a goal, then employing a strategy to achieve that goal at a level of risk with which you feel comfortable.

Let’s get started.

#2: Focus Your Strategy on Retirement Investing

Every investment goal has its own unique qualities. If you’re investing for retirement, you’ll approach your goal differently than you would if you were investing for your child’s college education or for another goal.

Our second tip for beginners who are foraying into the world of retirement investing, therefore, is to target your savings and investing goals towards retirement specifically.

You might, for example, take bigger risks with a pool of “fun money” that you’re investing. Or you might invest more conservatively in your 12-year-old child’s college education fund. But you should keep a different and specific strategy that’s geared towards retirement.

#3: Maintain LASR Vision

Think of your key investing steps with the acronym LASR. This stands for Location, Allocation, Selection, and Rebalancing.

Let’s review these one at a time.

Location – Choosing the Right Vehicles

If you locate your savings in the right spot, you can enjoy some great tax benefits. The most common retirement vehicles in the U.S. are “defined contribution” plans. For most people, that probably means your company’s 401(k) plan, and perhaps also a traditional or Roth IRA.

According to 2014 IRS regulations, if you’re age 49 or under, you can contribute a maximum of $17,500 per year to a 401(k) plan and deduct the full amount of that contribution from your taxable income. If you’re 50 or older, you can make an extra “catch-up” contribution of $5,500, for a total of $23,000.

You can also get a tax deduction from your contributions to a traditional IRA account, but here the maximum contribution allowed each year is $5,500 if you’re 49 or under. If you’re 50 or more, you can contribute an extra $1,000.

Roth IRAs work differently: your annual contributions are taxed as income, but the withdrawals you start to make after turning 70 are tax-exempt. In other words, you’ll pay taxes now in order to avoid paying taxes in the future. (The same is true for Roth 401k accounts, in case you have access to one. Some companies offer their employees Roth 401k access, but many do not.)

That means that if you’re 49 or under, you can enjoy $23,000 of tax-advantaged investing every year. If you’re 50 or older, you can enjoy an extra $6,500 in additional tax-advantaged investing.

Additionally, chances are good that your employer has a matching program, where the company will match your 401(k) contribution dollar for dollar up to a maximum (typically between 3-5%).

Allocation – Choosing the Right Risk-Return Mix

Now we come to the first –and most important – step in the actual investment process. This is called “asset allocation.”

Don’t let that phrase intimiate you. “Asset allocation” is a synonym for diversifying your investments.

Asset allocation involves creating a diversified portfolio that’s aligned to your goals, timeline and your risk tolerance.

You see, there are different “asset classes” such as stocks, bonds, and commodities like gold. Each of these asset classes is likely to have different risk/return profiles. Stocks, in general, are usually viewed as riskier investments than bonds.

Even within these broad categories, there are sub-categories like “Domestic U.S. stocks” vs. “Foreign Stocks.” And you can further break that down into “Developed Markets stocks” from places like Western Europe and Japan, “Emerging Market stocks” from places like China and India, and “Frontier Market stocks” from places like Ghana.

Each of these sub-categories of assets have different risk/return profiles, and they have different levels of “correlation” with other asset classes (i.e., some types of investments tend to rise at the same time that others fall).

As you can see, there are a lot of asset classes out there. And your retirement portfolio should have a healthy mix of all of these.

If your time horizon is sufficiently long – if you still have many years to go before retirement – then you want to position your portfolio for growth. You’ll want different kinds of equities, such as domestic and international, large-cap and small-cap, high growth and high dividend.

But you may not be entirely comfortable with the way equity markets can gyrate in the short term, even though historically they have produced higher long-term returns than fixed income assets. So depending on your risk tolerance, you will want to allocate a portion of your retirement portfolio to fixed-income assets (such as bonds).

Selection – Choosing the Right Assets

What are those “assets” we talked about in the previous paragraph? Typically, individuals investing into their retirement accounts use three types of assets: mutual funds, index funds and exchange-traded funds.

Typically, a 401(k) will offer you a limited menu of options – such as 15 or 20 funds across a range of asset classes. If you invest in an IRA, on the other hand, you can usually choose from a universe of more than 30,000 mutual funds and 2,000 ETFs.

Now it’s starting to sound daunting, you say. How can I be sure that I am choosing the right assets? How do I even start to think about this?

Rest assured, you can find plenty of help. Online tools like Jemstep’s Portfolio Manager can provide fund recommendations based on a wide variety of performance criteria, including return and risk properties as well as other important considerations like expenses. It also offers custom-tailored asset allocation advice that’s personalized to your age, risk tolerance and goals. A basic account is free.

Rebalancing – Choosing the Right Discipline

The final step of the LASR methodology is rebalancing.

Rebalancing helps you bring the value of your assets back in line with the your ideal asset allocation mix.

What does that mean?

Every year, different parts of your portfolio will do better or worse than others, and this will change your allocation weights. For example: Let’s imagine that on January 1, you invest 50% of your portfolio in stocks and the other 50% in bonds. During the next six months, stocks rise while bonds remain stagnant. By July 1, your portfolio may be 65% stocks and 35% bonds, because the value of stocks have grown so much.

When you rebalance, you bring your portfolio back to that 50/50 split (or whatever split you decide upon.) This helps you “lock in” your gains, while also buying more of the assets that are undervalued.

Rebalancing is a discipline that keeps your strategy on track for long-term success.

Make this the year that you take control of your financial future. Begin investing for retirement. The earlier you start, the more time your money can grow – which will eventually lead to a comfortable retirement.

Are you beginning to invest for retirement? Share your questions or thoughts below.