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3 Reasons To Be Flexible When Investing For Retirement

Investopedia logoInvestopedia 09-01-2016 Donna Fuscaldo
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Long gone are the days when you could set your investment plan and stick with it until you hit your target retirement date. With ever increasing volatility in the stock market, the prospect of higher interest rates in 2016 and a life expectancy that continues to get stretched, investors can’t be rigid concerning how they approach their retirement investing. After all, if they aren’t willing to be flexible, they can end up with a huge retirement savings shortfall that will drastically change the way they live out their lives in retirement. Here’s a look at three reasons investors have to be flexible when investing for retirement.

Interest Rate Environment Can Change Your Investment Returns

Coming off years of record low interest rates, many people saving for retirement have kept their money in bonds as a safe way to grow their nest egg. After all, if stocks decline, bonds should be a way to cushion the blow. But in a changing interest rate environment that strategy can cause more harm than good. That’s because when rates rise the yield on a bond typically goes down. Purchase a twenty-year bond at today’s rate and you’re likely to miss out on an increase in interest rates during the duration of the bond. That means after twenty years your investment will be worth less.

With the prospects high that the Federal Reserve will continue to raise interest rates, retirement investors who are willing to change their strategy won’t be exposed to interest rate risk. Instead of buying long duration bonds, a better bet in a rising rate environment is to go with short-term ones with maturities of no more than five years. Investors who are willing to be flexible can take advantage of a rising interest rate while those who remain rigid stand to suffer.(Read more, here: How To Prepare For Rising Interest Rates.)

Portfolio Will Get Too Conservative Or Risky

Many people investing with an eye toward retirement subscribe to the philosophy that the closer they get to retirement; the more risk averse they get. No one wants to live through another stock market crash just as they are gearing up to walk off into the retirement sunset. But that plan only works with a shorter life expectancy. Today, people are living well into their 80s and 90s which means they not only need to protect their retirement savings they need to make it grow. Sticking to an old investment plan that gets conservative as you age can create a big retirement shortfall. Not to mention that if retirement investors stick with a conservative philosophy they can end up with investments that don’t keep up with the pace of inflation. That can be disastrous because it will mean they will have less buying power for their dollars when they do get around to using them.

Being risky early on in your investment strategy and not revisiting it over the years can be just as problematic as being too conservative. If your portfolio is stock heavy and the market tanks that can evaporate some of your savings for retirement. And if it happens as you gear up to exit the workforce you may not have enough time to catch up. (Read more, here: Combating Retirement’s Silent Killer: Inflation.)

You Could End Up Paying Too Much In Taxes and Fees

Taxes and death are the only two certainties in life, but how much you pay in taxes is based on your investments and can change over time. Which is why being rigid in your investment plan can hurt you when Uncle Sam comes knocking. Take tax deferred accounts as one example—bonds and dividend paying stocks can provide investors with yield, but if the investments are in taxable accounts, any interest earned is going to be taxed as ordinary income. If the investments are held in retirement accounts like an IRA or a 401(K), the tax event becomes a non-event. Another reason not being flexible can hurt investors: they won’t be able to take advantage of tax loss harvesting, which is a popular way to avoid a capital gains hit. With tax loss harvesting investors offset the gains from one stock with the losses from another.

Taxes are one reason to stay flexible, and investment fees are another. Whether investors have their money in mutual funds or are investing in individual stocks if they set their investments and forget about it they could end up overpaying in fees. Without staying on top of your investments, you won’t be able to recognize an increase in fees or a rise in the turnover rate of the mutual funds you are invested in, which can cause tax events. 

The Bottom Line

Retirement investing isn’t one of those things that you can set and forget about. It requires investors to be flexible and willing to change along with the markets and environment. Investors who refuse can end up with investment losses, unnecessary tax hits and hefty investment fees. Not to mention a savings shortfall that can dramatically alter the face of their retirement years.

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