Investing for Retirement? 4 Critical Things You Should Know

Investing for retirement doesn’t need to be complex – especially if you have laser focus.

Or rather, “LASR” focus.

LASR stands for Locate – Allocate – Select – Rebalance.

What does that mean? We’ll explain.

Let’s look at these components separately and then see how they tie together as an integrated retirement investing strategy.

Investing for Retirement, Step 1: Locate

When we talk about “location” in the context of investing for retirement, we are referring to choosing investment vehicles that are best suited to your goals.

Most Americans planning for retirement choose either a 401k, 403b or similar employee defined contribution plan. Many also choose a traditional IRA and the Roth IRA. (There are other types of IRA’s, but these are the two most popular).

The 401k and the traditional IRA are tax-deferred vehicles, meaning that your annual income contributions are not taxed for that tax year. You will be taxed on the gains once you start making withdrawals.

By contrast the Roth IRA is not tax-deferred – you are taxed on that income as you go – but your withdrawals after retirement will be tax-exempt.

There are specific conditions that govern your eligibility to invest in each of these vehicles, and both the traditional IRA and the 401k have annual contribution limits (read more about 401k Contribution Limits in 2014 and IRA Contribution Limits in 2014).

Make sure you weigh the pros and cons of each retirement investing vehicle. The important thing, though, is to take full advantage of the benefits that come with whichever location option you choose.

Investing for Retirement, Step 2: Allocate

The next step is to allocate your retirement investments around your goals and risk tolerance.

This is a crucial step. Your retirement goals are not the same as your neighbors or those of some random person your age who lives on the other side of the country.

But if you opt for the target date fund approach – an increasingly popular staple of 401(k) plan offerings – you get lumped into the same strategy as everyone else planning to retire the same year that you do.

A better way to invest for retirement is to do the allocation yourself.

This means you should identify the return and risk characteristics of different asset classes. You should understand, for example, the difference between small-cap domestic stock funds and municipal bond funds.

Then divide.these asset classes into different weights based on how much you want to earn, how long you have until retirement, and how comfortable (or not) you are with day-to-day volatility along the way.

The longer you have to retirement, the more your portfolio should be oriented towards equities and other equity-like investments like REITS and commodities.

As you approach retirement you will want to shift more weight into income-oriented securities like bonds, high dividend stocks and preferred stocks.

Investing for Retirement, Step 3: Select

Next, select the securities you want to include.

In almost all cases it makes more sense to focus on pooled investment vehicles like mutual funds and exchange traded funds (ETFs), rather than try to pick individual stocks, bonds or other securities. The vast majority of investment pros fail to beat the market on a consistent basis, and you should not expect to do so either.

When you pick funds, don’t rely unduly on simple past performance. This is an unreliable indicator of future returns.

Also, don’t be fooled into thinking that funds with higher management fees offer any kind of performance advantage – they generally don’t.

You may want to take advantage of an online service like Jemstep’s Portfolio Manager, which will make selection recommendations for each of your asset classes on the basis of a wide range of evaluative attributes and criteria. Portfolio Manager is designed to help you lower fees, make better allocation choices, and lock in more money for retirement.

Investing for Retirement, Step 4: Rebalance

Finally, rebalance your portfolio at least once a year.

Rebalancing means selling off positions that have done well and buying additional exposure in underperforming asset classes. This keeps your allocation weights in line.

For example, if your target allocation for large cap U.S. stocks is 30%, and large cap U.S. stocks outperformed every other asset class for the last 12 months, your actual weight is going to be much more than 30%.

So you sell off some of your large cap funds and buy more of whatever underperformed during that period.

It sounds counterintuitive, but it is a time-tested component of savvy long-term investing.

The LASR approach doesn’t have to be overly time-consuming, nor does it require you to master complex investment theories. Resources like Jemstep’s Portfolio Manager can guide you through each of these four steps and equip you with the tools to invest for long-term success.

It’s your retirement. If you don’t take action, who will?