Investing is scary and fun at the same time. It’s scary because you know you can lose it all. It’s fun because you can earn major gains and see your balances soar, setting you up for retirement.
Whether you’re investing in a 401K or taxable investments, you have a goal – to make money. That doesn’t happen out of sheer luck or overnight. It requires methodical steps that start with the following three questions.
If you’re investing in your 401K, you’re obviously saving for retirement, but what are your retirement goals? Write them down and monetize them.
Are you thinking of traveling a lot, downsizing your home, or working to supplement your income? This determines how aggressive you need to be with your 401K investments. Do you need a lot more than the average person or is $1 million saved for retirement enough?
You won’t know until you write out your plan and look at the numbers.
Everyone has a risk tolerance – some more than others. Knowing what you can stand to lose is important. A good measure is determining how far you are from retirement. When you start young (say your 20s) you have a higher risk tolerance because retirement is more than 30 years away. That’s plenty of time to turn things around if the market falls.
Think about your long-term goals. What are you trying to achieve with your retirement fund? Is it a fund to supplement your overall wealth or will you live off of it entirely? The answer will determine how aggressively you can invest.
Your timeframe plays a few roles. We already discussed how it affects your risk tolerance. The shorter your timeframe, the less risk you can take. It typically takes 10 years for the market to straighten itself out after a major loss.
But also think about your timeframe in terms of what you want to achieve. Are you thinking of early retirement? You’ll need to invest more aggressively and change your lifestyle too. Living frugally during your working years helps you achieve the financially independent, retire early status.
If you want a traditional retirement at age 65 or so, you have longer and may not need to be as aggressive. In other words, you may invest slightly less now and take fewer chances with your investment choices.
Before you invest, create your plan. Know what you want and what risk tolerance you can handle. Use this plan often so you don’t make rash decisions when the market falls or you see your portfolio get knocked out of alignment.
Reassess your situation every year too. Life changes as things happen. If your plans change or your allocations don’t work out as you planned, regroup and change your allocations so you are better able to reach your goals during retirement.