Employers can help workers save for retirement through profit sharing. Maximizing your profit sharing account’s returns requires careful investment as well as considering your planned date of retirement and your comfort level with the investing process. You can generate tax-deferred income until you decide to retire.
All investments involve some risk and assessing the amount of risk you're comfortable with is crucial to selecting investments. Use a measurement like Beta, which compares the past volatility of individual investments against a benchmark like the Standard & Poor's 500 or Dow Jones Industrial Average, as a yardstick. Say a mutual fund comprised of blue-chip stocks has a Beta of 1.15 and its benchmark is the Dow. Since a Beta of 1.0 means an investment's past volatility has precisely tracked the benchmark, a Beta of 1.15 means the investment has historically been 15 percent more volatile than the Dow. Conversely, a Beta of 0.75 would mean the investment was 25 percent less volatile. Beta is a commonly used measurement and can be found on many investment research websites.
Securities typically perform best over time, not overnight. For example, the Dow Jones Industrial Average has gained 38 percent on average in each of the last 50 years. A closer look, however, reveals several years in which the Dow had negligible gains or significant losses. When deciding how to invest your profit sharing assets, take into account when you intend to retire and, by extension, when you will begin making withdrawals. If your retirement date is near, consider investments that aren't as susceptible to volatility, like mutual funds comprised of short-term bonds or dividend-paying blue chip stocks.
By including a mix of investment classes (stocks, bonds and cash equivalents) and individual investments (small-, mid- and large-cap stocks, government and corporate bonds) in your profit-sharing portfolio, you help to ensure consistent returns. While one or more might perform poorly at a given time, it’s unlikely they'll all slump at the same time. That means you're covered by the rest of the portfolio if one investment goes sour.
Your investment options might be limited depending on your profit-sharing plan. If it's a pure profit-sharing plan it might be sponsor-directed, meaning your employer has control over investing plan assets. However, if the plan has a 401(k) component it might be self-directed, meaning you can decide how to invest the assets in your individual account. Even a self-directed plan might limit investment selections to a core group of securities often made up of money-market and mutual funds.
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