Start creating your investment plan
Participating in your employer-sponsored retirement plan is a great first step in preparing for your future. The next step is to decide how you’ll invest your money. Creating an investment plan is easier than you may think. You can start by answering these three questions:
1. What is diversification?
Before you can build an investment plan for yourself, you’ll need to understand asset allocation, how it works, and why you need it.
Basically, asset allocation is the act of dividing your account among different investments. Instead of investing only in one stock, bond, or fund – which could be very risky if that one investment were to decline in value -- you’ll want to consider diversifying your money, or spreading out the risk, among different types of assets. The two major asset types are stocks and bonds.
- Stocks. Buying shares of a company’s stock makes the investor a part owner of the company. The investor can profit when the share price rises or experience a loss if the share price goes down. Some companies make periodic payments, called dividends, which may help boost investment return.
- Bonds. A bond is essentially an IOU sold by a borrower to an investor. The bond issuer (the borrower) promises to pay the investor a stated amount of interest and to repay the investor’s original investment when the loan term ends. Although not without risk, bonds are generally considered less risky and offer a lower potential for return than stocks.
Most retirement plans include a variety of funds or portfolios, that hold many different stocks and/or bonds. This helps to diversify your account, though you’ll want to explore diversifying even further by including a variety of different types of funds in your account.
2. How much investment risk are you comfortable taking?
In investing, there’s a relationship between risk and reward. Investments with the potential for high long-term returns generally present a higher risk of loss. However, as investment risk declines, so does potential return. In general, stocks tend to be riskier than bonds, and short-term investments tend to be more risky than longer-term ones.
Understanding how much risk you’re willing to take is key to a good investment experience. If you’re very conservative in nature – don’t like to take risks, can’t sleep at night knowing your investments may go down – then investing in aggressive funds may not be appropriate or suitable for you. Instead, you’ll want to match your tolerance for risk with the mix of funds you choose. Keep in mind that the wider your selection of investments (the more diversified you are), the less chance you’ll see big swings in your overall returns.
Some retirement plans include what are called asset allocation funds. Those funds are automatically diversified and typically labeled for investors by risk tolerance, such as the Conservative Asset Allocation Fund or the Aggressive Asset Allocation Fund. As easy way to start diversifying is to select an asset allocation fund that matches your risk tolerance.
3. How many years do you plan to invest?
If you won’t need your retirement savings for many years, you may be willing to accept greater investment risk in the hope of earning higher returns. As retirement nears, you may decide to take less risk, focusing more on preserving the value of your savings.
Some retirement plans include target date funds. Like asset allocation funds, these are automatically diversified. However, instead of being designed for a specific risk tolerance, they are built for a specific retirement date. For example, if you plan to retire around 2040, you’d choose the target date fund with that year in the title. Just as you will want to take less risk as you get closer to retirement, so will these funds reallocate into less and less aggressive underlying investments, the closer they get to their target retirement date. It’s important to understand that you will generally incur higher costs with the target date funds than if you were to invest directly in the underlying investments themselves.
Remember to review
However, you choose to diversify your money within your retirement account, remember that as your life changes, your investment needs may change too. So, make sure you review your investments often and make changes as necessary.
Keep in mind that, as with any investment strategy, asset allocation and diversification do not guarantee a profit and offer no assurance against risk of loss.
Important Note: Equitable believes that education is a key step toward addressing your financial goals, and we’ve designed this material to serve simply as an informational and educational resource. Accordingly, this article does not offer or constitute investment advice and makes no direct or indirect recommendation of any particular product or of the appropriateness of any particular investment-related option. Investing involves risk, including loss of principal invested. Your needs, goals and circumstances are unique, and they require the individualized attention of your financial professional. But for now, take some time just to learn more.
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