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Question: I know I should have a financial plan so that I'm not reacting wildly to
-- Tim J., Chicago
An investment plan provides two incredibly valuable benefits.
The first is that it creates parameters for how your be invested. That includes asset allocation, deployment strategies, and targets for exposure to individual , currencies, commodities and international markets. These are critical management parameters that impact the performance of your portfolio.
The second benefit of a good investment plan is that it creates a benchmark to evaluate the success of your strategy. If your goal is to return 75% of the Standard & Poor's 500-stock and your portfolio returns only 65%, that provides valuable information about your asset allocation and individual holdings. Without a benchmark, it's impossible to evaluate the performance of your portfolio, so having one is critical.
There are a number of -- including , , goals and risk -- that should be taken into consideration when developing an investment plan. But one of the most important is an investor's age.
The reason age is so important is it is one of the primary drivers of asset allocation. Asset allocation refers to a portfolio's mix of different asset classes, such as , , currencies and commodities. According to many experts, asset allocation is the single most important in performance.
The general idea of asset allocation is that as investors move closer to retirement, they want less risk in their portfolios. This is usually achieved by decreasing exposure to stocks and increasing exposure to fixed-income assets. However, record-low interest rates have been causing problems for investors.
That was on display in the first half of this , with the S&P 500 posting an impressive 13% while bonds suffered their worst second quarter in 25 years. That had serious implications for the performance of asset allocation strategies that were heavy in bonds.
The larger concept of asset allocation is to reduce risk as investors move closer to retirement, and that transcends all markets and short-term volatility. However, age is also important for reasons beyond asset allocation.
The first is that many retirement accounts have "catch-up" provisions that expand contribution limits for participants above a certain age. A traditional IRA allows participants who are at least 50 years old to contribute $6,500 annually, compared to the regular $5,500. The 401(k) allows account holders age 50 or older to contribute an additional $5,000 above the regular annual limit of $17,500. Both of those provisions provide older investors with special benefits that can have a big impact on invested, returns and .
Age is also important because of qualified distributions and required minimum distributions. Usually, the minimum age for withdrawals from the IRA and 401(k) is 59 1/2. Both plans also require account holders to begin making minimum distributions at age 70 1/2. Those are both important to consider when planning for retirement and tax strategy.
The Answer: As investors move closer to retirement, they generally want to assume less risk in their portfolios. That's why age is so important when creating an investment plan. It affects some of the most important areas of the investment process, including asset allocation, contribution limits and qualified distributions. Understanding how age affects different aspects of the investment process provides insights into asset allocation strategies and qualifies certain age groups for higher annual contributions limits.