Last Updated: March 9, 2009
Up, down. Up, down. These are curious times to be saving and investing for retirement. On one hand, it seems as if every dollar you contribute to your retirement plan is worth less each passing day. On the other hand, you are simply practicing a time-honored investment practice - buying low.
According to financial planners, these are indeed tumultuous times that demand not only a financial plan, as President Barack Obama recently noted, but an investment plan, or what planners call an investment policy statement or IPS. "Americans need to be more proactive regarding their retirement accounts," said FPA member, Jim Barnash, CFP®.
An IPS, which is typically built with the help of a financial planner, identifies your investment objectives, your time horizon and your risk tolerance. It is the foundation for all investment decisions, according to Norman M. Boone and Linda S. Lubitz, co-authors of FPA Press' Creating an Investment Policy Statement: Guidelines-Template.
Others agree. "In today's volatile market, an IPS can help our clients achieve the peace of mind of knowing that they are doing everything they can to preserve investment assets and protect their standard of living," wrote Christopher T. Lawson, author of Explaining IPS Benefits to Boomer Clients, an article that recently appeared in the FPA's Journal of Financial Planning's Between the Issues.
In addition to serving as a roadmap to help you achieve your investment goals, Lawson also notes that an IPS can help you avoid, what he calls, the "common destroyers of wealth." Those include inflation, over- and under-diversification, hasty decisions, arbitrary benchmarks, and chasing hot investments.
So, when it comes time to investing during today's market, building or revisiting your investment policy statement is the first order of business. And the first step to drafting an IPS, according to Lawson, involves an assessment of your financial situation through the identification of your individual goals and needs.
The second step in building an IPS involves assessing your risk tolerance, according to Lawrence. Are you aggressive in your investment strategy? Are you conservative? What is your time-frame for portfolio withdrawals? If you are unsure of how comfortable you are with risk, consider using a risk tolerance questionnaire that can help you determine your own comfort level. At the end of this process, you need to feel in control of your decision, according to Lawson.
Given today's market condition, however, risk tolerance seems to be a moving target. It's easy to be aggressive when the market's rising. But now, the pendulum is swinging the other way. And according to FPA member Jim Barnash, CFP®, now is the time to focus not on risk tolerance, but loss aversion.
Time horizon is another important element of investing and an IPS. If you are young and have a long-time horizon before you retire, Frank Armstrong, III, CFP®, author of The Retirement Challenge and president of Investor Solutions suggests that you should be thrilled by the opportunity at hand."You should be dancing in the street," he said."It's a great opportunity to buy stocks low and cash in later at tremendous prices."
If, however, you have a short-time horizon, it's time either to pat yourself on the back or to re-construct your portfolio. According to Armstrong, you should set aside a portion of your portfolio in safe, liquid investments to meet your cash flow needs over the next seven to 10 years, and then allocate the remainder of your portfolio in investments designed for longer-term goals and needs.
There are other factors to consider when investing in today's market. Barnash, for instance, recommends parking part of your money in cash as well, though for different reasons. "You want to be able to take advantage of opportunities that will come when the recovery begins," he said.
In building your long-term portfolio, both Barnash and Armstrong say there's a need to reduce the fees associated with investing. For his part, Barnash recommends the use of Exchange-Traded Funds, or ETFs or index funds.
To be sure, it's important to stay diversified when investing for the long-term, but given today's market conditions, Barnash also recommends, if you have the mindset for it, concentrating on specific sectors. "Go on the offensive," he said. "Look into areas like gold, oil, corporate bonds, all which can provide some gains or yields inverse to the markets today." In addition, these times require that you look not only at your retirement accounts, but your non-retirement accounts as well, said Barnash.
Of course, saving for retirement does mean identifying the amount of money you need set aside in your nest egg. That's part of an IPS too. And as a rule of thumb, Armstrong suggest saving at least 20 percent of your pre-tax money per year. To be sure, that might be a stretch for many. After all, the savings rate in America just hit 3 percent in 2008 for the first time in years. "We have an inability to save in any meaningful way," he said. And if you don't save enough money for retirement I can only confirm that you will be poor."
Armstrong also says having or hiring a financial planner would be a wise decision at a time like this. "We try to keep people from making bad decisions," he said. "The biggest risk people face is their own behavior and inability to keep a long-term perspective."