Over the last 30 years, a huge change has taken place in how Americans fund their retirement. Recognizing that change, and what it means to you, may be very important in determining what retirement lifestyle you can afford.

For much of the second half of the twentieth century, the retirement landscape was dominated by the defined benefit plan, commonly known as the pension. After you worked for your employer for a certain number of years, you could retire and the employer would pay you for the rest of your life. The amount was determined by a formula based on your age, years of service, career earnings and other factors. Over the years, your employer would invest money to be able to pay their obligation to you and other retirees. As the retiree, their investment returns were immaterial to you. The amount you received was predetermined and how well or poorly the investments did could not change that. In other words, the investment risk was all on the employer. In the early 1980s, that began to change. A new type of retirement plan emerged known as a defined contribution plan. The most popular form of the defined contribution plan is commonly referred to by the IRS code section that created it, section 401(k).

At first, defined contribution plans were offered alongside traditional defined benefit plans. Soon, employers started to recognize the benefits to them of replacing pensions with 401(k)s. The employer’s obligation under the defined contribution plan is limited to whatever they put in. There is no open-ended commitment and it is up to the employee to determine how to invest the money from a menu of choices offered by the plan. The investment risk was completely shifted to the employee. How well you invested the money became a factor in what kind of a retirement you could afford.

When the investment risk rested with the employer, they would often hire professional money managers and the management of the investments would be guided by a formal document called the investment policy statement.

An investment policy statement is simply a document that lists investment goals and the strategies that will be used to meet those goals. It doesn’t have to be formal document. Start by listing the goals you are trying to accomplish. You might include things like retirement, paying for your children’s education, or buying a second home. Next, prioritize the goals and determine how much you will save for each of the goals and how often you will make the contributions.

The next step is to determine the rate of return you will need to meet your goal. For example, if you have already saved $100,000 for retirement and you want to retire in 20 years with $400,000, and you plan on saving $6000 per year, you will need to achieve an average return of around 4% to meet your goal. Based on that, you can determine the asset allocation, or mix of stocks, bonds and cash, that you will use. During the 20 years that you are investing in this example, it is likely that you will experience many declines in the stock market.  Asset allocation does not ensure profits or protect against losses. However, determining your asset allocation ahead of time, might help to remove emotion from your investment decisions and add discipline to the process. You can also note whether you plan to manage the portfolio yourself or enlist professional advisors to help guide you.

Finally, determine how often you intend to monitor your performance and what criteria you will use. We recommend that you review your account performance and rebalance your assets at least annually, but you can do it more frequently if you’d like. Ultimately, you will want to measure your performance against the goals you have set out, but you should also measure against appropriate market indexes.

Emotion can be an enemy of long-term investment results, and adding the discipline of an investment policy statement may help limit the effects of emotion.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Guarantees of annuity payments are based on the claims paying ability of the issuing company.

Asset allocation does not ensure a profit of protect against loss.

Securities and financial planning offered through LPL Financial, a registered investment advisor.  Member FINRA/SIPC