Saving for retirement can seem like a really long way off when you’re in middle school, but it’s super important to start thinking about it early! One of the best ways to save is through a 401(k) plan, which is often offered by your parents’ employers. But the real question is, how do you pick the investments inside that 401(k)? It can seem a little scary, but don’t worry! We’ll break it down step by step.
Understanding Your Risk Tolerance
The first thing to think about is your “risk tolerance”. This just means how comfortable you are with the idea of your investments going up and down in value. If you’re okay with some ups and downs, you might be more willing to take on more risk to potentially earn more money over the long run. If you’re more cautious, you’ll probably want to choose investments that are a bit safer, even if they might grow more slowly. Your parents probably think about this too! Here’s a quick way to think about it:
Think of it like a roller coaster.
- High Risk Tolerance: You love the big drops and loop-de-loops! You’re comfortable with a bumpy ride.
- Moderate Risk Tolerance: You enjoy roller coasters but maybe aren’t a fan of the super crazy ones. You want some excitement, but not too much.
- Low Risk Tolerance: You prefer the Ferris wheel. You want a smooth, predictable ride.
Different types of investments have different levels of risk. For example, stocks (owning a small piece of a company) are generally considered riskier than bonds (loans to the government or a company). Since you’re young, your parents likely have a longer time horizon until they retire, which means they can take a bit more risk. This is because they have time to recover from any losses.
Now, what investments should my parents choose? They should consider a mix of stocks and bonds that aligns with their risk tolerance and the time they have until retirement. The younger they are, the more they may be able to invest in stocks. They’ll probably have some options within their 401(k) that help them balance their risk and return.
Looking at Investment Options
Your parents’ 401(k) plan will offer a selection of investment choices. These are usually listed in a brochure or online. It’s important to actually look at these options and understand what each one is. They might seem confusing at first, but they generally fall into a few main categories. Always start by reading the information provided by your parents’ employer.
There are usually several types of funds offered.
- Mutual Funds: These funds pool money from many investors to invest in a variety of stocks, bonds, or other assets. They are often managed by professionals.
- Index Funds: These funds track a specific market index, like the S&P 500 (which includes 500 of the largest U.S. companies). They offer broad market exposure.
- Target-Date Funds: These funds automatically adjust the mix of investments over time based on the investor’s target retirement date. They get more conservative (less risky) as the retirement date approaches.
When you’re looking at the options, pay attention to the fund’s “expense ratio.” This is the annual fee you pay to have your money invested. Lower expense ratios mean more of your money is working for you! Don’t worry, your parents can always ask for help from a financial advisor or their HR department to explain anything they don’t understand.
The goal here is to diversify. To diversify means to spread your money across different types of investments so that if one investment does poorly, the others can help cushion the blow. Think of it like a pizza: You don’t want just pepperoni (one type of investment). You want a variety of toppings (stocks, bonds, etc.) so you still enjoy the pizza if you’re not a fan of one topping.
Understanding Asset Allocation
Asset allocation is a fancy term for how your parents split up their investments between different asset classes, like stocks and bonds. Stocks offer the potential for higher returns but also carry more risk. Bonds are generally less risky but offer lower returns. Finding the right balance is crucial for your parents’ success.
The “right” asset allocation depends on a few things: their risk tolerance, how long they have until retirement, and their financial goals. Someone who is far away from retirement and comfortable with risk may be able to invest more heavily in stocks. Someone closer to retirement may want to shift more towards bonds to protect their savings. Here’s a general idea:
| Age Group | Stocks | Bonds |
|---|---|---|
| 20s-30s | 80-90% | 10-20% |
| 40s-50s | 60-70% | 30-40% |
| 60+ | 40-50% | 50-60% |
Target-date funds often take care of asset allocation for you. They automatically adjust the mix of stocks and bonds as they get closer to the target retirement date. These are a good option for people who want a simple, “set it and forget it” approach. Your parents should be able to tell how the fund adjusts and if that matches their long-term goals.
If your parents choose to handle asset allocation themselves, they’ll need to regularly review their portfolio (maybe once or twice a year) and rebalance it if necessary. This means selling some investments that have done well and buying more of those that haven’t, to get back to their desired mix. This helps them “buy low, sell high” and keep their investments on track.
Reviewing and Adjusting Your Investments
Picking investments isn’t a one-time thing. It’s important for your parents to review their 401(k) investments regularly, maybe once or twice a year, or whenever there are major life changes, like a big promotion or a new baby! This helps them stay on track with their long-term goals.
During the review, they should:
- Check Performance: See how their investments have done compared to the market and their goals.
- Rebalance: If their asset allocation has shifted (e.g., stocks have grown more than bonds), they might need to sell some stocks and buy more bonds (or vice versa) to get back to their desired mix.
- Consider Changes: Review if their financial situation or risk tolerance has changed. Are they getting closer to retirement? Do they have any new financial goals?
If their investments aren’t performing as well as they hoped, they can consider making some adjustments. They might shift to a different fund, change their asset allocation, or increase their contribution to take advantage of any market downturns. They shouldn’t make rash decisions based on short-term market fluctuations. Long-term investing is the name of the game!
They can also use online tools that many 401(k) providers offer. These tools can help them track their investments, compare their performance to benchmarks, and even get personalized recommendations based on their risk tolerance and goals. But be sure to check in with a financial advisor if they’re ever uncertain.
Conclusion
Picking investments for a 401(k) might seem complicated, but if your parents take it step by step, they can be successful. They need to understand their risk tolerance, research the options, choose an appropriate asset allocation, and then review and adjust their investments regularly. It’s all about creating a plan and sticking to it. Remember to consider those target-date funds! And most importantly, start saving early and make the most of any employer match. That’s free money, and who doesn’t love that?