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How To Give Your Retirement Accounts An Annual Checkup

How to Give Your Retirement Accounts an Annual Checkup

Most people wouldn’t dream of going year after year without ever seeing a dentist for a checkup, whether or not they have any signs of trouble with their teeth. Yet they’ll leave thousands of dollars sitting in their retirement accounts for decades without so much as looking to see how well those investments are doing. It’s vital that you check on the status of your retirement investments at least once a year, even if you haven’t noticed any obvious problems.

Changing priorities call for changing investments

Early on in your career, the top retirement priority is typically to get as high of a return as possible on your savings. If you’ve got several decades to go before you actually need to tap into that money, you have the luxury of taking some risks in return for getting bigger rewards. Thus, stocks are the best choice for young workers choosing investments for their retirement contributions. But as you get older and start approaching the big day, your risk tolerance will drop. If a 30-year-old chooses a retirement portfolio that drops in value by 25% the next year, it’s annoying, but there’s plenty of time for the portfolio to recover its value and then some. If a 60-year-old has a 25% drop in his retirement accounts’ value, that’s a bit more than an annoyance.

It’s important to shift your retirement investments over to less risky assets as you approach retirement, which brings us back to the need for annual checkups. Part of your checkup process will be shifting how you allocate your contributions between stocks and the less volatile and less risky bonds. A formula that usually works well is to subtract your age from 110, and use that result as the percentage of your retirement investments that should be in stocks. For example, if you’re 30, then 110 minus your age would be 80 — so 80% of your contributions should go into buying stocks with the remainder in bonds.

401k letters and piggy bank
Image source: Getty images.

Rebalancing reduces risk

Just because you set your contributions to the right percentages of stocks versus bonds doesn’t mean that your actual investment balances in your retirement accounts will match those desired percentages. This is a result of something that’s normally highly desirable in an investment portfolio: namely, diversification. Diversification means spreading your money out over several very different types of investments, so that if one type of investment performs poorly, it’s likely that the others (being so different from the first investment) will be holding steady or even going up. Of course, the fact that your different investments will be behaving differently means that the changes in value between those investments will also change the percentage of each type of investment in your portfolio. For example, let’s say that you have set your contributions at 80% stocks and 20% bonds. Over the last year, the stock market has thrived but bonds have declined in value….

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