3 investment options for passive investors
“Don’t reinvent the wheel, just realign it.” – Anthony J. D’Angelo
Over the past few months, I’ve had lots of conversations with employees who are filling out application forms for their group retirement plan. The one section of these forms that seems to cause people the most stress is the section which asks them to choose how their contributions to the plan will be invested. Often, people don’t feel as if they know enough about investing to make an informed decision and they’re worried that making the “wrong” choice could result In them losing everything they’ve invested if the markets drop.
This uncertainty often leads to people either not handing in their enrollment forms or not making an investment decision at all. The challenge with this is that, when you don’t give investment instructions for your contributions to a group retirement plan, the money is invested into the plan’s “default investment”. The default is often a very safe but very low interest investment which means it might not be the best investment choice for every employee’s time horizon and risk tolerance.
So, if you’re someone who doesn’t know a lot about investing and investments and who doesn’t want to commit a lot of time or energy to learning about investing or managing your retirement savings, what should you invest in? Here are three investment optionsto consider:
1. Guaranteed investments
Many group retirement plans offer a selection of guaranteed investments. These investments are a good fit for people who have a low tolerance for risk or who are less than five years away from needing to access their money. The investments offer a guaranteed rate of return over a period of time (often 1,3 or 5 years) and they are usually cashable, which means they’re not locked in and can be redeemed at any time before actual the maturity date without penalty.
Related article:A simple guide on guaranteed investing
2. Asset Allocation funds
A mutual fund is a pool of money that is managed by a fund manager. Investors buy pieces or “units” of the pool and then share in the gains (and losses) of the fund. Mutual Funds were created as a way for smaller investors to minimize their risk of ‘losing their shirt’ in the markets by allowing them to invest in a wide range of companies rather than having to choose just one or two companies to invest in.
Related article:Understanding Asset Allocation Funds
Asset Allocation funds are designed to be what I call a “one fund solution” and, because of this, they are a great option for passive investors. Rather than building their own diversified portfolio of 5-8 mutual funds and rebalancing it on a regular basis, an investor can just choose one fund that is already diversified and which will be rebalanced by the fund manager.
Related article:Understanding the art and science of rebalancing
Asset Allocation funds vary in volatility. To choose the right one for you, you need to determine your risk tolerance. In theory, the further away you are from needing to access your money, the more aggressive you can afford to be but you need to make sure that you’re investing within your comfort zone. A simple way to determine your risk tolerance is to think of risk on a scale from 1-10. If 1 is an investment that might gain 5% in a good year but lose 3% in a bad year and 10 is an investment that could gain 30% in a good year but lose 30% in a bad year where do you sit on the scale?
If you would rate yourself 1 or 2 then a conservative fund would be a good fit; 3 or 4 would be a moderate fund, 5 or 6 would be a balanced fund, 7 or 8 would be an advanced/growth fund and 9 or 10 would be an aggressive fund.
3. Target Date funds
Target Date funds are similar to Asset Allocation funds in the sense that they were also designed to be a one fund solution for investors. The key difference though, is that Target Date funds are also designed to get more conservative over time, making them a “set it and forget it” investment option. To choose the fund that best suits you, simply figure out which target date year is closest to the year when you’re planning to access your money.
Related article:Target date funds make investing easy
For example, I’m 40 years old, so if I was planning to retire at 60, I would choose a 2035 target date fund because that’s closest to my 2034 retirement date. Right now, the composition of that fund will be similar to a growth asset allocation fund but as we get closer to 2035, that composition will become more conservative so that by the time we get to 2035 it will look more like a conservative asset allocation fund.
Whether you’re choosing investments for your group retirement plan or for your personal plans, if you’re more of a passive than an active investor, these investment optionsare worth considering.