An Investment Strategy for Different Accounts
Due to this little IRS rule of RMDs, you will likely be using these funds BEFORE Roth IRA funds. THIS is what makes a big difference between the two accounts – TIME.
If you have been through any introductory 101 finance courses you’ve studied the time value of money. The more time you have on your side to stay invested the better off your portfolio is expected to be.
Let’s avoid getting into the details of statistical analysis, but basically the longer your time horizon for the funds the better your odds are for a successful outcome. This successful outcome can be in relation to risky assets. An example of these assets can be small-cap and emerging markets.
Asset Class Risk & Volatility
These two asset classes are inherently riskier when you are looking at their volatility, or how much they go up and down on any given day or year. That said, when you look over many many years and decades they have outperformed other areas of the stock market.
Logically this makes sense. You just do not know when this time period will be or be able to predict this. You do the best you can by being diligent and staying invested for long periods of time. This increases your likelihood of success by capturing the periods of outperformance in the riskier asset classes.
By this logic, typically you will be using your Roth IRA funds last, or you may even pass the funds on to the next generation, so you will want to place the riskier funds in this account.
Retirement Investment Strategies by Age
Many employer 401(k) plans have target-date retirement funds. These are used to make it easy on employees. You find your target retirement date based on your age and select the corresponding fund to invest your money in.
The issue with these funds is that they can become too conservative over time. Therefore, they can create an opportunity cost by not being invested more heavily in the stock market. This can significantly impact your rate of return over the long haul. This is why I’m a fan of building a more comprehensive portfolio when possible.
The concept of investing based on your age can still be helpful and dictate, to an extent, how you should be invested. As you get older and get closer to retirement or needing to use the funds, the more conservative you want to be. This is because you don’t have the time on your side to handle a large drop in the stock market and wait for it to recover.
How Much Money Do I Need In Retirement?
That said, it depends on what the need is from the portfolio. To me, this is the most important piece of the puzzle. You need to make assumptions and conservative estimates for larger expenses like long-term care. But overall you should decide on the fixed amount of income needed in retirement.
The less you need, the more risk you can take on therefore allowing you to be more heavily invested in stocks and vice versa.