If you’re going to build a house, you need an effective plan – a blueprint – to ensure the house is solidly built and will meet your needs when finished. Likewise, putting together an investment portfolio for your 403(b) or 457 plan calls for a strategy that defines the scope of your endeavor.
The past few years have been tough on many investors. It may seem like the stock market reacts – and sometimes overreacts – to news that doesn’t even register on your radar. At the same time, keeping your money out of the stock market and in conservative investments can yield next to nothing. What’s an investor to do?
Start with a Solid Foundation
The asset allocation you choose for your investment portfolio will have a major impact on the returns it earns and the risks you take. Asset allocation means dividing your investments among different asset classes, such as stocks (equities), bonds (fixed-income investments) and cash equivalents, (e.g., U.S. Treasury bills).
An asset allocation that’s appropriate for you depends on your:
- Time horizon – how long until you need to cash in your investments.
- Risk tolerance – your ability and desire to handle declines in the value of your portfolio.
- Goals – what you want your investments to produce, such as long-term growth or income. This may include a specific dollar figure; for example, “$300,000 over the next 25 years.”
Once you’ve chosen an asset allocation, you may want to go one step further by diversifying your investments within each asset class.* For instance, you may choose stock funds in with different styles (e.g. growth vs. value) and market capitalizations (e.g., small vs. large company funds), and bond funds with different maturities and credit ratings.
Erect the Structure
A framework of regular investments can pay off with a host of advantages.** Investing a set amount at regular intervals can reduce timing risk compared to investing a lump sum, since you will not risk investing all of your savings when valuations are high. With systematic investing, you balance investing when valuations are high and when they are low. Investing more when valuations are low puts you in a better position to take advantage of a market rebound, since the more shares you own, the more you participate in an upswing. Systematic investing also helps you stay disciplined and avoid investing based on your emotions.
If you participate in your 403(b) or 457 plan with payroll deductions, you are already taking advantage of a systematic investing program.
Regular Maintenance Keeps Your House in Order
It’s important to review your portfolio periodically to ensure it’s still appropriate as your life situation changes. You’ll also need to rebalance your investments as market performance makes your investments stray from their original allocation targets. To rebalance, you can sell shares of investments that have outperformed, buy more of those that have underperformed or a combination of the two.
A Good Architect Is Important
Working with a financial advisor can help you create an investment strategy that is right for you. Read the "CTA Guide to Working with a 403(b) or 457 Advisor."
* Diversification cannot guarantee a profit or protect against loss in a declining market.
** Systematic investing cannot guarantee a profit or protect against loss in a declining market. You should consider your ability to continue investing during periods of low price levels.