Contributed by Afford-Anything.com blogger Paula Pant
In my last post (December 2010), I discussed how freelancers can save for retirement — detailing the different types of retirement accounts a freelancer can open.
Today’s topic is what to do once you have cash in your retirement account.
If you’re like most people, you know that cash should be invested. But you might not know the first thing about stocks, and you’re scared off by all the rough-‘n-tumble market volatility of the last few years.
Don’t worry. You don’t need to know a thing about stocks. All you need to know are two things: your age and your tolerance for risk.
Since I assume you know your own age (or else you have bigger problems on your hands), you’ll need to figure out your risk tolerance. If your balance plummets and you lose half your savings, what would you do?
Most people are awful judges of their own risk tolerance, often assuming themselves to be able to stomach more risk than they actually can. When stocks are flying high, they’ll throw thousands into the markets and feel confident about their investing skills. When the markets crash, they pull back and convince themselves that they haven’t chickened out — they’ve just “changed their mind.” Then they walk away with half the money they started with. They keep this remaining money in a savings account and miss the eventual stock rally … and, in short, end up with the worst deal possible. All downside, no upside.
This is why honestly assessing your tolerance for risk is so important. Misjudging it can cost you thousands.
Click here for a quiz that helps you figure out your risk tolerance. Once you figure that out, follow two more steps:
Step 1: Use the “Rule of Thumb” to figure out what percentage of your portfolio should be in bonds and what percentage should be in stock funds (such as index funds and commission-free ETFs).
The Rule of Thumb states that 110 minus your age is the percentage of your portfolio that should be in stock funds. If you’re 30, then 80 percent of your portfolio should be in stock funds, and 10 percent in bonds.
Quiz yourself for risk tolerance at the link above. If you have an appetite for risk, increase this number to 120 minus your age (so a 30-year-old is 90 percent in stock index funds). If risk makes your stomach queasy, decrease this number to 100 minus your age.
Step 2: Divide your stock funds according to these three suggested risk-tolerance scenarios:
If you love risk:
40% domestic large-cap markets
20 % domestic mid-cap and small-cap markets
30% in foreign developed markets
10% in foreign emerging markets
If your risk appetite is only so-so:
50% domestic large-cap funds
30% domestic mid-cap and small-cap funds
10% foreign developed markets
10 % foreign emerging markets
If risk makes your stomach queasy:
60% domestic large-cap funds
15% domestic mid-cap funds
10% domestic small-cap funds
10% foreign developed markets
5% foreign emerging markets
Paula Pant is the blogger at Afford-Anything.com, a website that teaches people how to save, invest, and earn more. Follow her on Twitter @AffordAnything.