Staying on track with your retirement investments – Part 1

Investing for your retirement isn't about getting rich quick. More often, it's about having a game plan that you can live with over a long time. You wouldn't expect to be able to play the piano without learning the basics and practicing. Investing for your retirement over the long term also takes a little knowledge and discipline. Though there can be no guarantee that any investment strategy will be successful and all investing involves risk, including the possible loss of principal, there are ways to help yourself build your retirement nest egg.

Compounding is your best friend

It's the "rolling snowball" effect. Put simply, compounding pays you earnings on your reinvested earnings. Here's how it works: Let's say you invest $100, and that money earns a 7% annual return. At the end of a year, the $7 you earned is added to your $100; that would give you $107 in your account. If you earn 7% again the next year, you're earning 7% of $107 rather than $100, as you did in the first year. That adds $7.49 to your account instead of $7. In the third year with a 7% return, you'd earn $8 and have a total of $122. Like a snowball rolling downhill, the value of compounding grows the longer you leave your money in the account. In effect, compounding can do some of the work of building a nest egg for you.

The longer you leave your money at work for you, the more exciting the numbers get. For example, imagine an investment of $10,000 at an annual rate of return of 8%. In 20 years, assuming no withdrawals, your $10,000 investment would grow to $46,610. In 25 years, it would grow to $68,485, a 47% gain over the 20-year figure. After 30 years, your account would total $100,627. (Of course, these are hypothetical examples that do not reflect the performance of any specific investment and assume that no taxes are paid or withdrawals are made during that time.)

If your workplace savings plan contributions are made pretax, as most people's are, compounding really becomes a powerful force. Not having to pay taxes from year to year on either your contributions or the compounded earnings helps your savings grow even faster (though you'll owe taxes on that money when you start withdrawing from your account). The value of compounded tax-deferred dollars is the main reason you may want to fully fund all tax-advantaged retirement accounts and plans available to you, and start as early as you can. Investing money over time can help compounding produce potentially significant returns. With time on your side, you don't necessarily have to aim for investment "home runs" in order to be successful.

Diversify your investments

Asset allocation is the process of deciding how to spread your dollars over several categories of investments, usually referred to as asset classes. A basic asset allocation would likely include at least stocks, bonds, and cash or cash alternatives such as a money market fund. The term "asset classes" also may refer to subcategories, such as particular types of stocks or bonds.

Asset allocation is important for two reasons. First, the mix of asset classes you own is a large factor--some say the biggest factor by far--in determining your overall investment portfolio performance. How you divide your money between stocks, bonds, and cash can be more important than your choice of specific investments. Second, by dividing your portfolio among asset classes that don't respond to market forces in the same way at the same time, you can help minimize the effects of market volatility while maximizing your chances of long-term return. Ideally, if your investments in one class are performing poorly, assets in another class may be doing better and may help stabilize your portfolio.

Remember that during any given period of market or economic turmoil, some asset categories and some individual investments historically have been less volatile than others. You can manage your risk to some extent by diversifying your holdings among various classes of assets, as well as different types of assets within each class. Taking steps that can help manage the amount of volatility you experience can help you stay with your game plan over the long term.

Article courtesy of Forefield. Securities offered through NPB Financial Group, LLC. A Registered Investment Advisor/Broker-Dealer Member FINRA, MSRB, and SIPC