Investment Issues

Retirement planning used to be relatively easy. All you had to do was work with a good company for a large part of your career and then collect your pension checks in retirement. In recent years, the traditional employer-provided pension plan has undergone a transformation. Previously, most pension plan investments were directed by the employer or a trustee. Today, most employers have adopted, or are in the process of adopting, a 401(k) or a similar type of retirement plan. These plans give more of the retirement planning responsibility back to the employee. If you participate in such a plan, generally you must decide how your 401(k) plan assets will be diversified and invested.

Basically, a 401(k) plan allows you, the employee, to defer a percentage of your income. Many employers match your deferrals in some way, and your contributions and those of your employer are placed in a special retirement account for your benefit. You choose how you want your retirement account money invested.

Usually, you'll have the opportunity to make choices from among a number of investments ranging in style from conservative to aggressive. Some financial advisors believe an overly conservative approach to retirement planning may not provide sufficient funds for retirement over the long term. That's why many professional advisors recommend a growth or a moderate growth approach to investing when you're young, with a gradual shift to a more conservative outlook as you move closer to retirement age. Of course, your investment strategy depends not only on the number of years to retirement, but also on your individual goals and risk tolerance. Also, people are generally living longer, which means you may need money for a substantial period of time after retirement.

As a hypothetical comparison between a growth investment approach and a conservative one, assume you earn $50,000 a year and wish to retire in 15 years. Assuming you defer 10 percent of your income ($5,000) into a 401(k) plan each year and assuming your employer matches 50 cents on every dollar you defer ($2,500), you'll accumulate $7,500 annually in the plan. Assume you choose more conservative investments with a return of 6 percent annually; in this case your 401(k) account will grow to $185,044 in 15 years.

If inflation averages 4 percent a year, your 401(k) money will grow just slightly faster than inflation. If, however, you selected more growth-oriented investments and were able to earn a 10 percent annual return, our 401(k) assets would grow to $262,123 in the same period-a more than $77,000 difference between the conservative result and the growth result. Of course, this example is for illustrative purposes only. The actual results will vary depending on your specific investment choices and market conditions.

Most 401(k) plans offer a number of investment choices in a variety of risk categories. By diversifying among them, you can create a portfolio that best suits your personal situation, your financial goals, and your risk tolerance. IBI