Intention is powerful. We don’t give it enough thought. Most of us go though life unintentionally falling into a career path, unintentionally meeting (or not meeting) a spouse, unintentionally gaining weight and so on. Much like a pinball working its way through the machine, life swats at us, and we react.
We unintentionally accumulate investments in the same way. Perhaps you get a certificate of deposit. Then there is that annuity one person sold you. There is that Apple stock you “had” to buy and that mutual fund you read about in the latest finance magazine, along with the funds inside your 401(k) plan.
Pretty soon, you’ll have a collection of investments that may or may not be aligned toward a common goal.
If this sounds like you, what can you do to bring some intentionality to your investment choices? Here are three things you can do:
1. Get clear on what your goals are. The first thing you must do is understand your goals. I like the idea of writing a job description for your investments.
If you are 40 years old, do you care about the fluctuations in your portfolio value this week or next month? Probably not – and if you do care, either you don’t understand investing or you should stick with safe investments that aren’t going to have a lot of volatility. At 40, your primary concern should be a strategy that gives you the highest probability of maximizing returns over a 20-year time horizon.
If you are 64 years old, retiring next year, and will need to withdraw $50,000 from your investments, do you care about your portfolio value this week or next month? You bet you do. You don’t want to sell $50,000 of investments after a major market correction. At this point, you need to make sure your near-term cash flow needs can be met, regardless of the ups and downs of the market in the year or two after you retire. A laddered bond strategy may be perfect.
What about a Roth individual retirement account? With a Roth IRA, you can always withdraw your original contributions at any age without taxes or penalties owed. In that case, should your Roth IRA have a dual goal, with a portion of your contributions invested safely as your emergency reserve fund, and any excess invested aggressively, with the idea you won’t touch it until age 70 or older? For those without an adequate emergency fund, this might be the perfect job description for their Roth IRA.
2. Evaluate the most effective solutions. Once you have a goal, you evaluate the choices most likely to help you achieve the goal. This is more difficult than you may think. Often, a simple portfolio of only a few index funds is more likely to achieve your goal than something far more complex.
For example, low costs have been proven to be one of the best indicators of a smart fund choice, yet people are still drawn to funds with fancy strategies and high fees. There are hedge funds, private placements, options writing (puts and calls), precious metals funds, biotech funds and many other fun, more exotic choices. But are they any more effective at helping you achieve financial security than a plain portfolio of index funds? Probably not.
Inside your 401(k) plan, the most effective solutions are often the professionally designed model portfolios or target-date retirement funds. Outside your 401(k) plan, such options work just as well.
You can include a few small tweaks so investments that have high turnover or generate a lot of interest income are tucked inside your retirement accounts, while investments most likely to deliver long-term capital gains and qualified dividends are held in nonretirement accounts. This type of tweak will help you take advantage of the lower tax rate on long-term capital gains and qualified dividends.
What about solutions that provide guaranteed income, like a variable annuity with an income rider? If you are 10 to 15 years from retirement and your goal is to create a certain level of income that is available to you at your retirement date, this annuity is like insurance for a portion of your retirement money. It insures a minimum level of retirement income.
3. Begin a transition plan. Once you are clear about your goal and the most effective solutions, you can make a transition plan. Most of the time there will be tax consequences, and perhaps surrender charges, if you rearrange your entire investment collection at once. This is why a transition plan is needed.
Your transition plan accounts for all tax consequences, your overall allocation and risk level and fees and penalties. For example, as you near retirement, you may know you need to reduce risk. You may be able to strategically wait to realize capital gains until you will be in the zero percent capital gains rate the year after you retire. To keep your risk level appropriate, maybe you reduce risk in your retirement accounts now, as there are no tax consequences to making changes within those types of accounts. Then you plan on reducing risk in your nonretirement accounts once you are in a lower tax bracket.
What about that variable annuity you bought a few years ago? If the guarantees in the annuity provide a certain level of income, there is no downside risk to an aggressive position within the contract. It may make sense to be very aggressive with the investments inside it, as that gives the annuity the best possibility of delivering a result that is better than the insured outcome. This is a change that could be made right away.
Remember to be intentional. The closer you get to retirement, the more intentional you need to be. When you retire, your money has a specific job to do for you. Picture that pinball going through the machine. Bouncing around is fine as long as you get to your goal, but as you get closer to retirement, you’re going to want a much smoother course to the finish line.
Dana Anspach, certified retirement planner, retirement management analyst, Kolbe Certified Consultant, is the founder of Sensible Money, LLC, a registered investment advisor with a focus on retirement income planning based in Arizona. She is the author of “Control Your Retirement Destiny” (Apress), writes for About.com as its Expert on MoneyOver55 and contributes to MarketWatch as a RetireMentor.