Investing may seem like a daunting topic, but doing your research can pay off – literally. Making educated investing choices can give you an excellent start to your post–working-life nest egg.
One easy way to start out on the right investing track is to start a 401(k). A 401(k) is an employer-sponsored retirement plan that you can contribute to with your pre-tax dollars. Typically, a very small amount per paycheck is contributed (3-6%).
In your 401(k), your money will compound over time. You can see a chart of what your investment could look like over time right here.
Investments you may have heard of are stocks, bonds, mutual funds and annuities. Some of these may appear to be a little more complicated, but should not be feared. Each investment type has its own pros and cons, so it is important to educate yourself on each before diving in.
Stocks can offer the potential for higher returns; however, returns are not guaranteed and can widely fluctuate. Plus, there’s always a risk that you can lose the original principal that you invested. Bonds offer lower long-term return potential, but historically they have been less volatile than stocks.
A mutual fund is a portfolio of investments – generally a mix of stocks, bonds and other securities – that is held and managed by one company. Many mutual funds offer their investors the option to diversify their holdings, as the funds include several different investment classes and/or types of investments, depending on the fund’s investment objectives.
When you own a share of one stock in one company, that stock’s value can fluctuate dramatically up or down each day. When you own a share of a diversified mutual fund, your investment can also fluctuate, but the fund’s diversification can potentially reduce the fund’s overall volatility. How? If one stock in the fund goes down, another may go up. Keep in mind, though, that although diversification can help reduce the overall volatility in a mutual fund, there is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk, as there is always the chance that your investment may lose value.
An annuity is a longer-term investment vehicle that includes both an investment and insurance component. Annuities can provide income for years of retirement, but understanding the costs involved is important before making the decision on this investment. Fixed annuities can provide a fixed income for a set number of months or years – similar to a certificate of deposit. However, it is important to note that certificates of deposit are FDIC insured and annuities are not. Variable annuities can only provide income based on investment terms and market conditions. If the money used to purchase an annuity is invested aggressively, the investment can potentially react as such. Indexed annuities allow investors to participate in a stated percentage increase of an index. Returns can be capped, but risks can be lower because there is protection against downside risk.
Another factor to research when considering investing is asset allocation, which is an element of diversification. Asset allocation is essentially reviewing the investments you have and verifying that they are varied based on your age, time frame and risk tolerance. All of your investments are a blend of risk and opportunity. Asset allocation does not ensure a profit or protect against a loss.
Sources: americanfunds.com, sec.gov, learnvest.com, investopedia.com, google.com
Investing involves risks including possible loss of principal. Past performance is no guarantee of future results. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price. Variable and Fixed annuities are suitable for long-term investing, such as retirement investing. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 are subject to a 10% IRS penalty tax and surrender charges may apply. Variable annuities are subject to market risk and may lose value.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
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