How much of your money should you invest in stocks and how much in bonds and/or cash equivalents? As a retirement investor, that may be the biggest decision you have to make.
Choosing an investment mix would be easy if you could know right now how much stocks, bonds, and cash equivalents will earn in the future. Unfortunately, the only numbers available to guide you are past returns, and they can never predict what any investment’s future performance will be.
Still, history does offer some useful guidance. The long-term returns of equities (stocks) have beaten the returns of fixed-income investments (bonds) and cash equivalents. However, the short-term returns of stocks have been very volatile. Stock values have often dropped or gained sharply and quickly, and it can take a long time for prices to recover after a drop. That means there’s a high risk of earning poor returns or losing money with stock investments. Bond values are less volatile — and cash equivalents much less volatile — than stocks.
The more of your retirement plan account you invest in stocks, the higher its overall risk becomes. And the more you invest in bonds, cash equivalents, or other lower risk investment options, the lower the overall risk. But don’t forget that investing in different asset types (called “diversification”) can help manage risk. The overall risk of a well-diversified mix of different investment assets may be lower than investing an entire account in just one of the lower risk assets.
Also, the possibility of future inflation complicates your choice because the average returns of low-risk investment types have generally been close to the rate of inflation. But you need inflation-beating returns to achieve real investment growth.
Your Investment Mix
How much investment risk are you comfortable with? What investment returns will be enough (together with contributions) to meet your long-term goals? You need a combination of investment options for your plan account that has the potential to deliver the needed gains without exceeding your risk tolerance.
Ultimately, creating an investment mix is a matter of balancing the potential for earnings and risk. Your plan administrator can provide more information about choosing investments for your account. No single mix is right for every investor, but there is one that’s right for you, based on your individual goals and risk tolerance.
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