How do you get the balance right?
April 2010
You’ve chosen your ideal retirement date, you know broadly how much you can afford to save every month, but how do you go about investing your savings?
There are three core considerations when constructing an investment portfolio: time, risk and diversification.
Time
Note the year you started saving, your intended retirement date and the difference between the two is your investment timeframe. Although you are almost certainly investing for the long term, your investment approach should be considerably different if you are aged 30 and don’t intend to retire until you are 65, than if, say, you are 50 and are looking to leave work in 10 years or less.
This may strike you as counter-intuitive when you are trying to reach your investment target, but the shorter your investment timeframe the more cautious you probably need to be.
In the last 10 years before you retire, most people tend to gradually ease back on higher risk investments and move into more stable investments that could provide you with lower risk returns to secure a future income, such as lower risk bonds and cash.
Risk
The kind of investment portfolio you put together will equally depend on your own attitude to risk. Although the length of time you are invested for can go some way to moderate the level of risk incurred when you invest in shares, there are some people who are simply not happy to invest on the stock market where they could lose their capital.
You are probably all too aware of the risks, with the recent volatility in the markets and the dotcom bubble burst in 2000. The stock market stayed in the doldrums for the best part of three years back then. If you are approaching retirement and had invested solely in equities, then your pension would have dropped substantially!
If this were always the case, nobody would invest on the stock market at all. But they do, because the principle generally remains true that a higher risk holds the potential, but not a guarantee, of a higher return. The important thing is to strike a balance.
Diversification
There’s more than a grain of truth in the old saying ‘don’t put all your eggs in one basket’ and possibly the best way to manage risk is to spread your holdings. Just as buying the shares of one company is riskier than putting your money into lots of companies, if you invest in only one type of asset you are increasing your risks. So spread the risk, diversify.
Only when you have got these three key investment criteria in balance can you move on and decide exactly what you should be investing in.
It sounds complicated and it is. Even if you have never taken financial advice before, planning for retirement is the time to do so, it can make the difference between a comfortable retirement and a poor one. If you need to find a financial adviser, you can search for one here.
