How much of your retirement savings should be invested in the stock market?
Author: Christy Bieber
Source: The Motley Fool
Building a hefty nest egg for retirement is essential. Most people have to invest in the stock market to achieve this objective because otherwise, it's too hard to earn a reasonable rate of return.
But while investing in stocks has historically been proven to be the best way to build your wealth, it's not without risk. In fact, because of the chance you could sustain losses, you want to have at least some money outside of the market in other investments.
The big question is: How much is the right amount of stock to own? The answer will depend on several factors.
Two key factors determine how much retirement savings go toward stocks
There's no one-size-fits-all approach to determining the amount of your retirement savings that should be invested in the market because a lot depends on two big factors: Your risk tolerance and the amount of time before you'll need your money.
If you're already retired and are drawing from your investment accounts, you don't have much time to wait out market downturns. In fact, you may have to sell some assets at a loss if you need to make a withdrawal to cover your bills during a market crash and don't have time to wait for the inevitable recovery.
If you're decades away from retirement, on the other hand, you've got many years (and likely many market cycles) before you'll need cash from your account. You can afford to wait out bear markets so you don't lock in losses that happen on paper during tough times.
Because your age and date of retirement matter so much, there are a few common rules of thumb that can help you determine the amount you should have in the market. One is called the "Rule of 110" and it involves subtracting your age from 110 and investing that much money into the market. Under this rule, a 20-year-old would invest 90% of their retirement account balance and a 50-year-old would invest 60%.
There are also other rules, like the Rule of 120 or the Rule of 100, and you can probably guess how those work -- you'd subtract your age from 120 or from 100 and invest that portion of your money in the market.
The second key consideration -- your risk tolerance -- will tell you which of those rules you should use. If you want to be aggressive in your investing, you don't mind taking a little more risk, and you're pretty confident you can pick good investments, the rule of 120 might be a better fit for you. But if you tend to get nervous when putting your money on the line, you may decide to opt for the rule of 100 instead.
Of course, when considering the amount of risk you're willing to take on, you can't forget about the risks associated with investing too little. The more of your money you keep out of the market, the less chance you have to earn generous returns, and the more you have to save to end up with the same nest egg. You may decide you're happy to invest more to limit your downside risk, but you should make that choice consciously rather than simply out of fear of equity investing.
Make sure you have the right asset allocation to meet your needs
Having either too much money or too little money invested in the stock market can put your retirement security in jeopardy. To avoid taking on too much risk -- or risking earning too little on your investments -- make sure you evaluate your investment strategy and asset allocation every year. You'll need to shift things around as you get older, but making the effort is well worth doing.
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