SOME BASICS OF INVESTING
Investing for retirement can seem like an overwhelming task. But with a basic understanding of some key concepts, you can quickly and easily create an investment strategy that matches your needs.
The process is easier if you consider that your choices boil down to just three types of investments: stocks, bonds, and short-term investments. Although your plan may offer many investment options, they basically fall into these basic groups, or “asset classes.” The mix that you choose – and the percentage of your savings you elect to put into each – is your “asset allocation” strategy. To find the mix of investments – that is, your asset allocation strategy – that’s appropriate for your portfolio, you need to consider three factors – asset class, risk and time. Simply remember that there’s an A-R-T to investing.
“A” is for “Asset class”
Your plan offers you a range of investment options within the three separate asset classes:
- Stocks – also called “equities”
- Bonds – also called “fixed-income investments”
- Short-term investments – such as money market funds or cash equivalents
Each of these asset classes offers specific advantages – such as greater potential for growth – and disadvantages – such as greater investment risk. Historically, the better the investment return, the greater the investment risk. The safer and more stable the investment, the more modest its earnings are likely to be.
As you develop an appropriate investment strategy, you’ll consider investing a percentage of your money in each of the three asset classes, depending on your needs and goals. For example, a person with a long time horizon before retirement may seek the highest potential return that stock asset classes offer.
“R” is for “Risk”
Investing always involves some risk. But not investing your money is risky as well. While you can’t avoid risk completely, you can take steps to manage it. There are generally two types of risk you should consider:
- “Investment Risk” is the chance that your investment can lose value in the market. Many retired investors who are cautious about risk may make the mistake of choosing only conservative, income-producing investments. As a result, they may lose out on two counts: to the growth potential of a healthy stock market and to the eroding effects of inflation on the dollar. Although it can be a bumpy ride, the stock market has historically offered a much better chance of higher earnings over long periods that other types of investments
- “Inflation Risk” is the chance that your investment return might not keep pace with the cost of living. Many people don’t like the idea of their money losing value, so they take what they think is the “safe” route and invest mostly in such investments as certificates of deposit (CDs) and Treasury.
No matter how far away you are from retirement, it makes good financial sense to create a long-term retirement strategy. After all, every decision you make today could affect how you spend your retirement tomorrow.
And with Americans living longer and spending more time in retirement – and taking greater responsiblity for their retirement future – the decisions you face will be different than those of any previous generations.
How do you know where to invest your money? With different investment options available to you, how do you choose what’s best for you and your situation as you consider retirement? The first step to answering questions liek these is to determine your asset allocation strategy – how you invest your savings across the three asset classes of stocks, bonds, and short-term investments (such as money market funds or cash equivalents).
Properly used, an asset allocation strategy can help you reduce your investment risk and even increase your potential for better returns over time. Generally, choosing an appropriate asset allocation strategy for the long term and sticking with it is a better approach than trying to stay ahead of the markets.