When saving for retirement, it is advisable to get familiarize with the various assets involve with your investments portfolio.
One of the main thing to consider is to ensure that you are diversifying your funds. There a lot of investment options in the market today as more and more financial products are being introduced.
Different funds are designed for different objectives so depending on how close you are with retirements, your investment selection will vary.
There are various risk involved with each retirement plan and this should be the next consideration for a saver. The longer you are from retirement, your retirement portfolio should be focusing on growth. As you get closer, you should start considering on moving the funds to a much safer haven so you don’t take a big hit if there is a big downfall in the stock market.
But lets discuss the three most common types of investments that you need to understand when saving for your retirement:
Cash Equivalents
As the term implies, these are like cash or easily convertible to cash such as your bank savings accounts and money market funds. Cash equivalents are designed to maintain the steady value over-time and are considered as low-risk investments
Money market funds are normally invested in treasury bills and other short-term securities. Majority of these funds are insured by FDIC for $250,000 so even if the bank shuts down, you can be assured that you can get up to $250,000 of your money back.
However, the rates of return on these types are very low that it does not outpace the inflation rate. As safe as these cash equivalents are for your retirement plans, investing heavily on this may not be a good strategy if you are young and looking for growth on your investments.
On the last note, if you are closer to retirement, moving majority of your funds to cash equivalents should be a top priority.
Bonds or “fixed income” investments
Bonds are one of the financing methods for corporations or government entities to raise funds. In other words, these are debts carried by them but instead of borrowing money from a bank institution, these are debts broken down into shares that are sold in the financial market, which are made available to the public.
If you have a bond, you pretty much are a creditor for that particular institution. The income from a bond is considered fixed and depends on the stated interest rate. The interest payment paid by the institution is your investment income.
Please keep in mind that since these are traded in the market, your actual income may vary depending on how much it is traded as well. History shows that bond investments grow more slowly but more steadily than stocks.
Equity Investments (Stock or mutual funds)
Buying stocks or mutual funds means owning a piece of the company. Historically, equity investments provide the highest return among the three investment options but it also gives you the greatest risk of loss.
Equity investments are good choices for long-term investors because of the growth potential that they provide. So the strategy should be allocate more in equity while you’re young because you have more time to recover even if the market crashes. Overtime, the rate of return with equity investments beat out the other two.
A word of precaution, when the stock market crashes a couple of years ago, investors who have major exposure in equity investments lost at least half of their nest egg. It’s too bad for those people who are closer to retirement, they have to work longer in order to recover their losses.
That’s why most experts emphasizes gradually moving most of your funds to cash equivalents as you get closer to retirement so you don’t take a big hit when a market crash occurs.
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