As mentioned in my previous article, there are three distinct phases to successfully plan your retirement: Accumulation, Protection, and Distribution.
There are several strategies, major strategies, that can be used during the accumulation phase. They include Asset Allocation, Diversification, Dollar Cost Averaging, and Protection. Several of these strategies will be covered below.
Let's jump right into Asset Allocation. Here we have two simple words, and we can easily define each. An Asset is something that we own, but in this case, let's assume this is an investment vehicle rather that something other property you own like real estate, or cash value in a life insurance plan. These are all Assets, but for argument sake, we'll focus on our retirement plans and other savings. So, how do we want to define Allocation? Your favorite dictionary would likely define allocation as "part," "share," or "portion." That's perfect for our purpose!
I remember my first experience with an IRA. At the time, I was reading the money related magazines that were popular back then. I read that Europe was doing well. I even checked the past history of the fund, so I put 1/3 of my money into the European Fund. Unlike the typical person making their first investment decision when they become eligible for their company offered plan, I had three months to contemplate my decision.
Boy did I blow it! I thought I knew it all. I also read that the Pacific Basin was experiencing gains, so I found the relevant fund... another 1/3 of my IRA. I thought I knew enough to at least warn me that I was very heavily invested in international funds, so I put the rest of investment into an Equity Income domestic fund. Within six months, my IRA was down about 40 percent.
I later realized, yes the brain started to finally tick, that I made three major mistakes. The first was that I really didn't have a strategy, other than making money as quickly as possible on my investment. Secondly, I didn't have an Asset Allocation plan. And third, I was reading yesterday's news and chasing previous results in Europe and the Pacific Basin (Asia). These funds had done remarkably well, but by the time I entered the "market," it had changed.
That was 30 years ago and I was just starting my Air Force career. Based on what I've seen in my past 14 years in financial services, 90 percent of investors are making the same mistakes. They are "chasing market" returns, and have not established a fundamental strategy. This may not apply to you, but I offer you this challenge if it does not: What is your strategy? At that time, I also did not understand the principle of Diversification... a very important component toward developing how Assets are Allocated.
Asset Allocation is how you have allotted or portioned your retirement money in your Personal IRA, SIMPLE, 401K, 403B, 457 Plan, etc. If you're like most folks, you made a decision when you started your account, and you were not quite sure what you were doing. That's OK... that puts you into the vast majority of retirement plan eligible employees. You started participating in your plan. Let's face it, that's the single most important component of retirement savings. You have to get into the game and you did that.
The U.S. Security and Exchange Commission (SEC) offers a very simple explanation for Diversification and to why this is important... "Even if you are new to investing, you may already know some of the most fundamental principles of sound investing.” How did you learn them? My guess is that you were provided certain empirical experiences or ordinary, real-life experiences that have nothing to do with the stock market.
For example, have you ever noticed that street vendors often sell seemingly unrelated products - such as umbrellas and sunglasses? Initially, that may seem odd. After all, when would a person buy both items at the same time? Probably never - and that's the point. Street vendors know that when it's raining, it's easier to sell umbrellas but harder to sell sunglasses.
And when it's sunny, the reverse is true. By selling both items- in other words, by diversifying the product line - the vendor can reduce the risk of losing money on any given day. If that makes sense, you've got a great start on understanding asset allocation and diversification."
Suffice it to say that the SEC explanation is superb. You simply don't want to put "all your eggs in one basket." As an example, if you happen to work for a large company and have the option of putting company stock into your 401K, that's good.
You work for the company, like the company, and you're hard work is going to make that stock more valuable in the future. Very commendable! You get an "A" for effort.
However, if you put all you retirement contributions into your company stock, your Diversification score is a resounding "F." Most large reputable companies, MetLife is a company I worked for and easily comes to mind as an example, only lets you contribute a certain percentage of your overall weekly, bi-weekly, semi-monthly, or monthly contribution to their stock fund.
I would also like to like to emphasize an advantage you have over my situation as earlier described. I had made decisions based on my lump sum contribution to my IRA. My decisions had to better than yours, albeit they were terrible. Since you regularly contribute to your employer sponsored retirement fund, you have a major advantage. You have the power of "Dollar Cost Averaging."
OK... OK... I know I'm guilty of throwing a third term into this equation of Accumulation, but it's a term you need to know. Simply put, it doesn't' matter as much to you if the market is down, or if you lose money in a quarter or even consecutive quarters (though if you are losing in too many quarters, you probably want to talk to your financial account representative responsible for your company's plan). That's because Dollar Cost Averaging gives you an advantage when the market is down.
When the market is down, your mutual funds are down, and their share value is down. But, since you are contributing regularly to your plan, you're purchasing new shares at reduced prices or reduced share value. You are buying them at a discounted or “For Sale” value. You are doing well. Don't forget the old axiom that I'm sure you are familiar with: "Buy Low, Sell High." This is key to successful retirement fund management.
