How much money should you have invested in stocks vs. bonds? What kind of stocks should you invest in? How much should be invested in what?
There are many questions we ask ourselves when we pick investments for our retirement accounts.
A simple way to look at it is what I like to call “The Bucket Approach.” Here’s what it is:
Think about how much money you currently have. We’ll call this your nest egg.
Your nest egg is probably made up of bank accounts, deferred comp accounts, other retirement accounts, maybe an annuity, etc. Let’s pretend you pick up your nest egg and walk across the street to your neighbor’s house and he has three buckets laying out on the floor.
Short Term Bucket
He tells you that you should take your nest egg and put enough stuff in the short-term bucket to last you the next 3-5 years. Let’s say you think you would probably need $25,000 from your nest egg in any given year. You would want to put $75,000- $125,000 worth of stuff in your short-term bucket. This “stuff” should be invested quite conservatively- cash, fixed accounts, high quality corporate bonds, and US Treasury bonds.
Medium Term Bucket & Long-Term Bucket
Your neighbor then tells you to fill up your medium-term bucket. This is money you think you could need in roughly 5-10 years from now. The third bucket is for money you could need in over 10 years from now.
These are the buckets you can use to buy stocks.
In the medium-term bucket, you can buy diversified stocks primarily in large US companies. These stocks can fluctuate in value, and even take a beating and be down over short periods of time. But, if diversified, there is a good chance that these investments will appreciate in value over time. If they do, you take some stuff out of the medium-term bucket and you put it back into the Short Term Bucket.
The long-term bucket is for your more aggressive investments- Small Cap Stocks, Mid Cap Stocks, and foreign stocks. This is money you know you will not need to access for over 10 years. These investments will take a beating from time to time, but that’s okay, because you have at least 10 years for them to recover and grow.
I would like to add here that it is really important for your investments to be diversified. A good way to diversify is to buy ETF’s or mutual funds.
An ETF is an exchange traded fund and it is pretty much a stock that owns a bunch of stocks. You can own 1 ETF that owns all 500 companies in the SP 500.
By investing in diversified ETF’s or mutual funds, you remove yourself from a position where you are making a bet on any one individual company, and you are instead making a bet on an entire industry or economy.
In my opinion, I have much more confidence that American businesses as a whole will continue to grow over time than I do with any one company.