So, you’ve drank the retirement Kool-Aid. You understand the power of contributing to a tax-deferred plan and you know the benefits of dollar cost averaging. You even know that it doesn’t pay to be tardy for the retirement contribution party because starting to save early is EVERYTHING. Now it’s time to go all in and select your investments. 

In most retirement plans you have two choices when it comes to investment selections: Investing in a target date fund or picking your own investments. Today, we’re going to talk about how to select your own investments. Next week, we’ll get into target date funds. 

The process of selecting investments is called asset allocation. According to Investopedia, asset allocation is an investment strategy that aims to balance risk and reward by apportioning a portfolio’s assets according to an individual’s goals, risk tolerance and investment horizon...but we’re about to glamsplain this ish ...

When you choose investments within your retirement plan you are going to take into consideration how much time you have before retirement age as well as how scared you would be if you lost thirty percent of your money (the official term for that sick feeling of loss or comfort with loss is risk tolerance). In general, stocks have more risk than bonds. Now, that doesn’t mean that you put all of your money into bonds if you don’t want to loose money. Stocks represent more potential opportunities to make money. No one wants to loose money. This is why you should choose a mix of different asset classes, stocks and bonds, that are appropriate for you so that when markets start to trip you don’t get whiplash and hurt feelings over the rocky ride.

Its also a good idea to throw an alternative asset class into the mix to lower the volatility of your portfolio. The alternative asset class available on most retirement plan platforms is real estate. Adding something else to the mix that doesn’t move like stocks or bonds lowers the volatility and increases the chance for more return in your portfolio. Check out the chart below. A portfolio with 30% stocks and 70% bonds has less risk but less chance of making money than a portfolio with 70% stocks and 30% bonds. However, the portfolio with 60% stocks, 20% bonds, and 20% alternatives (usually real estate within your employer’s retirement plan) has less volatility than the 70% stocks/30% bonds portfolio but also provides an opportunity to make much more money.

Most retirement plan websites have an asset allocation evaluator that will allow you to plug in some basic information about your time horizon and risk tolerance and will calculate an appropriate allocation for you.