How you invest your contribution dollars can impact the level of return and risk in your retirement account. It's very important to make investment decisions in a way that suits your total savings needs, your comfort level with risk and your time horizon until retirement.
What are assets, anyway?
In the investment world, assets break down into three primary classes: stocks, bonds and money market instruments. Each offers different levels of risk and return possibilities. Even within an asset class, you'll find choices with higher risk and higher return potential.
- Stocks carry higher risk than bonds or money markets. In the short term, prices may jump around a lot and you may even lose money — but historically, stocks have provided the greatest potential for long-term growth. However, there are no guarantees for the future.
- Bonds tend to behave differently than stocks, because they provide a fixed rate of return. When a bond matures, you should receive your principal back — but again, this is not guaranteed. Bonds offer a wide range of risk/return characteristics, from very conservative to higher risk.
- Money markets offer the lowest rate of return, but involve the lowest risk of fluctuations in value. They may be best for short-term goals or for emergency savings.
How do I know what to invest in?
Start by asking yourself the fundamental questions:
- What's my savings goal? How much do I expect to need when I retire?
- What's my level of risk tolerance? How comfortable am I experiencing any ups and downs in the value of my investments over time?
- What's my time horizon? How much time do I have until I need the money?
Your answers to these questions will help determine how you divide your money among the different asset classes (asset allocation) and also how you divide your money among different investment choices within each class (diversification). The goal of asset allocation and diversification is to manage risk by balancing the strong performance of some securities against any poor performance from others.
Keep in mind: Although investment options such as mutual funds can relieve you of the responsibility of choosing individual securities, the process of selecting a fund still requires careful thought.
Investment professionals see plenty of common mistakes among both new and experienced investors:
- Overreacting to short-term changes in the market
It's important to monitor your retirement portfolio but you should understand that ups and downs are likely to happen from time to time. If your retirement portfolio declines in value, remember that staying the course can provide potential long-term benefits.
- Emotional investing
We're all human. However, it's wise to try to make investment decisions based on your savings goal, time horizon and risk tolerance rather than your gut reactions. Investments are not good or bad by themselves — it depends on your broader objective.
- Following the rule of thumb
Don't let well-meaning advice-givers or "what everybody's doing" take the place of a careful review of your circumstances. If you ever have any questions or concerns, always consult your financial representative.
- Timing the market
It's very difficult to successfully predict market behavior and time your investments accordingly — even for seasoned investment experts. Instead, consider selecting your retirement investments with the goal of holding on to them for a long period of time. As your holding period lengthens, changes in the value of your portfolio may become less pronounced.