The last time you looked at your 401(k) or other investment portfolio, you probably weren’t happy with how the current economic times were affecting the growth of your nest egg. But in slow economic times, should you expect your money to continue to grow, and is there a way to minimize—or even eliminate—losses?
While there isn’t a way to bulletproof your investments from short-term losses, you can put a bulletproof vest on your long- and short-term financial goals. How? Through variations of the bucket system.
The bucket system teaches you to include in your investment accounts various types of mutual funds, stocks, bonds and even savings accounts based on when you will need the money and your acceptable risk levels.
For instance, if you know you’re going to need money in the next two years for a down payment on a home or for your son’s or daughter’s college tuition, you want that “bucket” of money to be in safe investments such as a money market account, short-term CDs, short-term bonds or savings accounts, says Peggy Cabannis, president of HC Financial Advisors Inc.
When the economy is doing well, it’s a common mistake to leave cash for immediate needs in a mutual fund in hopes of making a little more profit before withdrawing funds.
But, Cabannis says, when markets turn sour, you could lose a large chunk of your investments—without having the time to make it back in the future. An example is a mutual fund dropping 10 percent in value when you had $75,000 saved for your new home. You just lost $7,500 of your down payment. But if you’d taken the $75,000 out just three months earlier and put it in a savings account with an annual rate of 2.5 percent, you would have earned $468.75—guaranteed.
But for long-term investing, you have time to ride out the highs and lows of the economy to earn a higher return on your investments. The amount risk you accept should be a balance between the time you have left until retirement and how much you think you will need. If you are at least 10 to 20 years from retirement, Cabannis says, 10 to 20 percent of your investment accounts should be in fixed-income investments—the safe methods mentioned earlier.
If you have five to 10 years left before you retire, you should have 40 to 50 percent of your portfolio invested in fixed-income investments. Cabannis says the rest of your portfolio should be spread among funds in an assortment of asset classes with various risk levels, such as dividend-paying stocks, international mutual funds, mutual funds containing stock in small companies and mutual funds containing stock in large companies. A good goal to shoot for is a portfolio of investments that average 7 to 8 percent yearly growth.
How much can you earn at a rate of 7 to 8 percent growth? Putting away $400 a month for 20 years will produce almost $236,000 dollars. While putting away the $400 per month in a high-risk fund that you think will average 12 percent, could possibly earn closer to $400,000, but the risk is too great.
Sit down with your financial advisor and figure out what you need to fill your money buckets with for years to come. If you plan ahead, your financial future can be bulletproof.