In previous pages, we have covered:
- Setting your financial goals
- The most common investment assets (asset classes)
- Understanding risk and working to determine your level of risk aversion
In Investment Strategies, we will use those topics as the foundations for determining your investment strategy. An investment strategy provides you with the blueprint for:
- Determining the mix of asset classes that will allow you to save for your goals, while matching your risk profile
- Selecting investment options that minimize taxes now and/or in the future
- Managing your investments going forward to keep your investments on track toward your goals
- Evaluating your strategy and making adjustments as your situation and goals change
Asset Allocation is the combination of stocks, bonds and cash that make up your total investment portfolio. Individuals who are more risk averse or need income generated from the portfolio will likely use a conservative portfolio, investing in a higher percentage of cash and bonds. Investors who have a longer time horizon or want to generate higher returns will likely use a larger allocation of stocks in their portfolio.
Below are some potential portfolio combinations, from conservative to aggressive, in terms of the percentage of each asset class included in your total investment portfolio. The most aggressive approach is typically for those investing for the long-term and who can handle a high level of risk.
|Potential Portfolios using the three Asset Classes|
|*These percentages are examples and not meant to be suggestions.|
When you are in your 20s and 30s and saving for retirement, you might use a Growth or Aggressive portfolio as you have time to ride out the market fluctuations. As you age and retirement gets closer, you may want to rebalance your portfolio to a Balanced and finally a Conservative portfolio.
Tax-Preferred Investment Options
Using tax preferred investment options throughout your investment strategy might reduce your overall taxes and significantly increase how your money works for you. It is important to understand the tax implications of your investments.
Some government and municipal bonds provide earnings that are free from federal and/or state and local taxes. These investments may offer attractive returns due to the fact that any income earned is subject to lower or no tax.
Tax-deductible Contributions with Tax-Deferred Earnings
This investment type allows investors to contribute pre-tax dollars, and the earnings on these investments are not taxed in the year in which they are earned. Taxes are paid on the contribution and earnings when distributions are taken. Some examples are:
- 401(k)s and 403(b)s: Employer sponsored retirement accounts. The IRS sets limitations on the allowable annual contribution amounts. Learn more at the IRS’s website about 401(k)s and 403(b)s.
- Traditional IRAs: The IRS allows limited contributions to IRAs based on adjusted gross income levels. Learn more at the IRS's website and Fidelity’s website.
Distributions from the above investments may incur a penalty if withdrawn before age 59½. IRS required minimum distributions usually are required by April of the year following the year you turn age 70½.
After-tax Contributions with Tax-Deferred or Tax-Free Earnings
These investments are funded from dollars that have already been taxed, and earnings are not taxed in the year in which they are earned. Upon distribution, the earnings may or may not be taxable. The IRS sets limited annual contribution amounts. Examples include:
- 529 college savings plans: Earning distributions are tax-free if used for qualifying college expenses. Learn more at investor.gov and savingforcollege.com.
- Roth IRAs: earning distributions, once you are age 59½ and your account is open for at least five years, are tax-free. The IRS allows some tax-free withdrawal provisions before age 59½ for first-time homebuyers and college expenses. Learn more at the IRS's website and Fidelity’s website.
- Non-traditional IRAs: earnings grow tax-free, but taxes are paid on the earnings when you withdraw funds. Learn more at the IRS's website.
Tips & Resources - Investment Strategies
This material is for informational purposes only and is not intended as investment, tax, financial, legal or other advice. Your personal decisions should be based on the recommendations of your own professional advisors.
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