How to Invest for Your Retirement Portfolio
Investing for retirement doesn’t have to be confusing or complicated. When you understand some basic principles, it becomes surprisingly easy to implement.
Let’s review the fundamentals and discuss how you can construct a simple, effective retirement portfolio.
What matters in your investment portfolio for retirement?
There are factors you can control and those you can’t in investing.
Markets are moved by tomorrow’s news. You can’t predict what that news will be. Whether it’s geopolitical events, earnings reports, or actions by the Federal Reserve impacting interest rates, none of those are within your control.
The good news is there is much you can control, and those factors can significantly impact your returns. Here’s a partial list:
Asset allocation: Asset allocation is the way you divide your portfolio between asset classes (cash, stocks, and bonds). According to Vanguard, this decision has “the biggest effect on the way your portfolio will act.”
Diversification: Diversification follows the adage, “not putting all your eggs in one basket.” When you diversify your portfolio, you allocate assets to minimize exposure to sources of risk.
A well-diversified portfolio includes a mix of different asset classes, like stocks, bonds, commodities, and cash, in an allocation consistent with your need and ability to tolerate risk.
Your stock portfolio should be further diversified between domestic and international stocks because, over the long term, it’s impossible to predict which will outperform. Having both domestic and international stocks will likely help moderate volatility and deliver competitive risk-adjusted returns.
If you have a portfolio that’s properly diversified, a stunning 88% of your investment experience (the volatility of your portfolio and the returns you will earn) can be attributed to your asset allocation.
Low fees: John Bogle, the iconic founder of Vanguard, stated: “In investing, realize that you get what you don’t pay for.” Bogle railed against the high cost of investing, which includes commissions, management fees, investment expenses, and taxes. Those costs reduce your returns.
You may find it surprising that mutual funds with lower costs (called “expense ratios”) have historically outperformed more expensive ones.
Paying higher fees has another, more subtle cost. The money you pay in fees isn’t invested and doesn’t benefit from compounding over time. The impact of this lost “opportunity cost” can be significant.
Don’t forget the fees you pay your advisor, which can also add up over time. For some investors, using a low-cost financial advisor may meet their needs and improve their returns.
Taxes: There’s a big difference in the tax impact of index funds and actively managed mutual funds.
Index funds attempt to mirror the returns of a designated index. Actively managed mutual funds attempt to beat the returns of a designated index, using professional money managers to select investments.
Index funds (and exchange-traded funds) usually distribute fewer capital gains because there’s less turnover in their portfolio. Actively managed funds often generate more taxable capital gains because of higher turnover in their portfolio. If these funds are held in a taxable account, you’ll incur higher taxes.
Understanding your retirement portfolio
Your portfolio is dynamic and not static. Over time, you’ll want to adjust it to accommodate your changing goals, risk tolerance, and time horizon. Your portfolio will likely consist of taxable and non-taxable accounts.
A taxable account is funded with after-tax money. The purchase price of the assets in that account creates a basis that won’t be taxed when the asset is sold.
A non-taxable account is typically a retirement account like a 401(k) account or a traditional IRA. Taxation is delayed until the money is withdrawn. You are taxed at your marginal tax rate at the time.
These two types of accounts make up your retirement portfolio.
Simplifying your investments in retirement portfolio
There are many factors to consider when deciding on an investment retirement portfolio. Given the impact of asset allocation, diversification, low costs, and taxes, a compelling argument can be made for limiting your investments to low-cost index funds or exchange-traded funds.
If you elect to go this route, it’s disarmingly simple to implement. Here are some options:
One fund portfolio: You may meet your retirement goals by investing in one index fund for both taxable and non-taxable accounts. The fund can be a low-cost target date fund from fund families like Vanguard, Charles Schwab, or Fidelity.
These funds are broadly diversified and automatically rebalance as you age, making them hassle-free.
Another attractive single fund option is Vanguard’s LifeStrategy Funds. These funds are available with different asset allocations, so you can pick one that fits your goals, time horizon, and risk tolerance. Unlike target date funds, the asset allocation in LifeStrategy Funds is fixed, so you may have to transition to a less risky option over time.
Two fund portfolio: If you want more control over your investments and allocate investments between your taxable and non-taxable accounts, you can consider a two-fund portfolio.
The funds might include an all-world stock ETF, like Vanguard’s Total World Stock ETF (VT). It seeks to track the performance of the FTSE Global All Cap Index, which includes both well-established and still developing markets. It has a very low expense ratio of only 0.07%.
For the fixed-income portion of your portfolio, you can consider Vanguard’s Total Bond Market ETF (BND). It tracks the performance of a broad, market-weighted bond index and has an expense ratio of only 0.03%.
When you understand what matters and what doesn’t in investing, you’re well-positioned to select a retirement portfolio suited to your unique requirements.