Should You Invest Aggressively?

Dear Carrie: I have $34,000 dollars in an IRA that I want to diversify in aggressive stocks. I retire in five years. How should I do this? Michael

Dear Michael: Your situation is interesting because it brings up a key question that every investor must ask: what’s the best way to invest that suits your timeline and feelings about risk? So, before we get into how to invest in aggressive stocks, I think we need to back up a bit and ask a more fundamental question: should you?

The answer depends not only on how many years you have until retirement, but also on what percentage of your portfolio this $34,000 represents and how much risk you’re willing to take.

For instance, if this money represents all or a significant portion of your retirement savings, investing aggressively might not be the right choice. The more aggressively you invest, the greater the potential for loss. Stock prices, particularly over short periods, can fluctuate wildly. Consider that annual returns for the S&P 500 index have ranged from -37 percent to 28.7 percent over the past 10 years (2000-2010). And a more aggressive portfolio could have had even more extreme swings. Can you handle this kind of risk so close to retirement? Should you?

HOW MUCH OF YOUR PORTFOLIO TO PUT IN STOCKS

Before you make any investment decisions with the $34,000, I suggest you look closely at your entire portfolio. How much do you already have invested in stocks? Do you have enough in bonds and cash? As you near retirement, you actually might want to consider a more conservative investing approach. For example, a typical moderate portfolio might have 60 percent stocks, 35 percent bonds and 5 percent cash. A more conservative portfolio might reduce the stock holdings to 40 percent and up the bond and cash percentages to 50 percent and 10 percent respectively.

How does your current portfolio match up? If you already have a high percentage in stocks, that IRA money might be more suitably invested in something else. But if, after considering your overall portfolio, you’re still intent on investing in stocks, then you’re right that you need to make sure you’re adequately diversified. That’s no easy task, so here are some guidelines to help you get started.

WHAT A DIVERSIFIED PORTFOLIO REALLY MEANS

We all know that putting too much money in any one stock can be a risky decision.

If that stock goes down, your portfolio can take a big hit. But does owning two stocks mean you’re diversified? Does owning five or even 15? Not necessarily. An ideal diversified stock portfolio is made up of several different investments across industries, sectors and countries. Some investing experts suggest that to have a truly diversified portfolio of individual stocks, an investor should have $100,000 or more invested in a minimum of 30-40 high-quality stocks that include large-cap, small-cap and international. That can be a tall order for many individual investors. What can you do if you have less than that to invest?

AN ALTERNATIVE: DIVERSIFY WITH MUTUAL FUNDS OR ETFS

For a better chance of diversification with the amount of money you have to invest, consider equity mutual funds or exchange-traded funds (ETFs) many of which invest in a broad range of stocks. You can focus on growth funds for a more aggressive approach. You can also increase your diversification by choosing different types of funds. For instance, a large-cap equity fund or an international fund may incur greater risks than a domestic fund. Or you can get broad-based diversification with an index fund.

Of course, diversification will not prevent losses, but it can help cushion you from market volatility. Be sure to research funds and read the prospectus thoroughly before investing as it contains information about investment objectives, risks, charges and expenses. If you’re not an experienced investor, get some advice to help you find quality funds and show you how to evaluate performance, turnover rate and operating expenses.

PLANNING AHEAD

As you near retirement, there’s a lot to consider above and beyond how to invest this specific amount of money. For instance, how close are you to your savings goal? Do you need to save more aggressively now? What will your expenses be? How will you create a retirement paycheck?

With that information in front of you, it will be easier to decide how best to invest the money in your IRA both for today and for your future financial security.

Carrie Schwab-Pomerantz, CERTIFIED FINANCIAL PLANNER ™ is president of the Charles Schwab Foundation and author of It Pays to Talk. You can e-mail Carrie at askcarrie@schwab.com. This column is no substitute for an individualized recommendation, tax or personalized investment advice. To find out more about Carrie Schwab-Pomerantz and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at www.creators.com.