Winning the Race Between Time and Money – Part III: Personal Savings and Investments
Individual savings and investments are the third primary source of retirement income. When you retire, you no longer receive a paycheck, so principal preservation and safety should be high on the list of key investment objectives. The question is: what investment vehicle should you choose? In the perfect world, the ideal vehicle would have all the following characteristics:
• High rate of return
• Tax efficiency
In the real world, however, such a “perfect investment” does not exist. Individuals must choose from a confusing range of investment vehicles, with varying degrees of risk, returns, and characteristics. The chosen investment vehicle for your personal funds depends on your risk tolerance, time horizon, income needs, tax bracket, and investment skills and experience.
There are certain proven strategies to consider for risk management:
1. Diversification: Also known as asset allocation, the goal of diversification is to spread your market risk around among different asset types. This strategy takes advantage of negative correlation among different asset types to smooth out the ups and downs in your portfolio over time. Stocks, bonds, cash, are the investments often used, although other products such as precious metals, real estate, and other alternative investments may also be included.
2. Position sizing and stop losses: for the stocks in your portfolio, two of the most underused but very effective risk management strategies are position sizing and stop losses. While position sizing determines how much of a particular stock to hold in your portfolio, stop losses help determine when to exit the market. Having a pre-determined exit strategy is an important part of equity investment.
3. For income tax efficiency, the general rule is to withdraw the money you need first from your personal savings and investments before dipping into your qualified retirement accounts so the latter can continue to enjoy income tax deferral status and allow you to keep more of what you make. If you are 70-1/2 or older, you must, of course, take the minimum distribution amounts required to avoid the hefty 50% deficiency penalty.
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