Are there any basic rules for investing in my retirement plan?
1)You only need 5% to make your money last forever*
This is the formula that many foundations and universities use when they are calculating how much income from their endowments they can use each year.Let's assume that you have determined that you need $30,000 a year after retirement. This means that you will have to have $600,000 at your retirement date.
This is calculated by dividing the yearly payments by 5%. (30,000/.05 = 600,000)
*On average the $600,000 will grow more than 5% - enough to provide the $30,000, and to throw off enough so the account value and the payout both keep pace with inflation.2) The rule of 72
The rule of 72 will tell you how long it takes for an investment to double in value.* To get your result, simple divide the number 72 by the interest rate you expect to earn on your investment.How it works: If you believe that you will average a rate of return of 8%, dividing 72 by 8 will tell you that your money will double in 9 years.
The rule itself is not a prediction, but a mathematics fact. Of course, the predicting part comes in when you assume what you'll earn on your investment. For that reason you had better err on the side of caution.
Historically bonds have averaged a return of 6% and stocks - as measured by the S&P 500 - have returned 10% since 1926, but there have been 10-year periods where returns were significantly lower. So be conservative but realistic, depending on your time horizon.
*Assumes interest is paid annually and reinvested in the same account.3) The rule of asset allocation
As a base line, use your age as a percentage and that percentage should by in more conservative investments such as bond funds and money markets. Then 100 minus your age is the percentage that should go in more aggressive investments such as stock funds.Once you have these numbers, adjust for risk tolerance and your needs.
i.e. Despite your age if you are a conservative person who breaks out in hives at the thought of any negative returns on your investments, even in the short term, you need to establish investment patterns to the conservative side. On the other hand if you are 55, planning on retiring at 65 but not needing any distributions from your retirement plan until you are 68 and you have a higher risk tolerance, then you still have time to leave a larger percentage in the more aggressive investments. (5 to 10-year minimum time horizon)
4)Don't diversify too much
Diversifying between sectors is a good idea, but when you spread you money too thin, the diversification can drag down the returns instead of enhancing it. By investing in mutual funds you don't have to sweat it out wondering if you picked the right stocks. A professional money manager, who is buying and selling the stocks for you, runs the mutual fund.
