Your long-term strategy needs this five-year expense plan.
As you get closer to retirement age, don’t forget about the importance of cold hard cash.
Investors in their 50s should remain aggressive in their investments, but they should also be forming a retirement strategy that includes starting to set aside cash when they’re about five years away from when they’re planning to retire.
“The reason I use that as a rule of thumb is that generally even if the market goes down a lot, it will recover within two years,” says Chris Carosa, the New York-based author of Hey! What’s My Number? How to Improve the Odds You Will Retire in Comfort. “You don’t want to be forced to take money out of your investments because the market is going down.”
People are retiring at such different ages these days, primarily between 60 and 70, so it’s important to have your own five-year-plan and start your savings account accordingly. A cash account is important because you want your savings in something in which you can’t lose money.
“You can do a money market or buy a bond,” Carosa says. “Don’t buy a bond fund. That’s not something that protects your money – as interest rates rise, your investment in a bond fund will decrease.”
Starting a cash account about five years before your planned retirement gives you enough time to save two years’ worth of cash accumulated for expenses – a better calculation of how much money to keep on hand, instead of hyped-up numbers like “million dollars.”
“Once you retire, always try to maintain a two-year cash surplus, so you’re only spending from your cash account and not your investment account,” he says. “That way your investment account can continue to be invested for your growth.”
This is hugely important, because even after you actually retire, we all have to remember that we potentially have another 20 to 30 years to live. So people shouldn’t immediately become too conservative in an effort to avoid investing mistakes when dealing with retirement.
To stay on top of things during retirement, Carosa says it’s important to look at all sectors and simply make sure your latest investment is financially sound. Diversification works best with large-cap, mid-cap and small-cap stocks.
One piece of Carosa’s advice that he says “goes against the grain of what’s popular right now” is that instead of focusing on a target date fund, he recommends investing in a target risk fund or balanced equity portfolio. He explains that a target date fund is a multi-asset class portfolio with stocks, bonds and cash, and it will become more conservative as you approach the particular date associated with the fund. Just how conservative depends on choices that the particular fund makes.
The target risk fund can also be a multi-asset class fund, but it does not change whether it’s moderate, conservative or aggressive. It maintains the same risk throughout.
“If you need good long-term growth, then you probably want to be in a pretty aggressive or moderately aggressive target risk fund,” Carosa says. “That will have a little bit of bonds, but mostly equity.”
Carosa advises people who are going to invest in a mutual fund to not be bothered trying to figure out how to divvy up investments. Instead, buy one fund where the professional takes care of that in the portfolio.
For those working with an advisor about what funds to invest in, Carosa says that you might want multiple funds, but there’s a risk of over-diversification.
If you buy three mutual funds – one small-cap, one large-cap and one mid-cap, you have in essence created an index fund, he says.
“If you buy those types of funds, you are buying an actively managed fund, which means you are paying ten times more in investment management fees at the fund level than you need to,” Carosa says. “You just created a defacto index fund. If you wanted to create an index fund, then just buy an index fund. That is a major warning that applies to all fund investors for people who invest for themselves or people who invest through their 401(k) plan.”