Investment choices generally fall into three groups: Stocks, Bonds, and Short-term Investments.
Stocks - ownership interest in the company issuing the stock. If the company does well, then share price increases and you make money. If the stock goes down in price, you lose money. Stocks offer the highest potential investment returns, but also involve the most amount of risk to your principal.
Bonds - loans issued by the government, corporations, or other issuers of debt. Typically, bonds pay a fixed rate of income over a set time period. At the end of the time period, the face value of the bond is returned to the investor. Bonds rise and fall in value depending on current interest rates. The general rule is if interest rates rise, bond prices fall and if interest rates fall, bond prices rise. Bonds generally involve less risk of loss than stocks, but also offer lower potential returns.
Short-term Investments - comprised of short-term maturities and pay interest to the shareholder. Money Markets are an example of this type of investment. These investments offer the least risk of loss of principal, but pay potential returns that are generally lower than returns on both stocks and bonds.
Diversification and Asset Allocation
Diversification means spreading your money among different investments. "Don't put all of your eggs in one basket." Using Mutual Funds, which often invest in hundreds of individual securities, is the first step in diversifying your portfolio.
In stock funds, if one company or industry has problems, you should not suffer a major loss because the fund is sufficiently diversified. A bond fund usually invests in bonds with varying maturity dates issued by various entities, providing protection if an issuer defaults.
Investing in different types of funds increases your diversification. For example, international and domestic funds or funds investing in large companies versus small companies. Of course, while diversification helps to reduce risk, loss of your principal is still possible.
Deciding on which investments to select is step #1. Now you must select how much money to put in each investment, a process known as Asset Allocation. Your Asset Allocation decision will depend on retirement age, your return expectations, and your risk tolerance.
Review the investment information that has been provided to you in your enrollment packet to learn more about the investment options available under your plan.