The Basics of Investing

How does a person even begin to understand the basics of investing for retirement when the investments sound complicated and confusing? Start at the beginning.

Make a Plan for Your Plan

What are your goals? How much will you need to live comfortably during retirement? When will you retire? When you know what you will need from your retirement savings, you can you put together a plan that’s right for you. Next, you need to understand some basic investment concepts.

Diversification

"Don’t put all your eggs in one basket" is a popular phrase, even on Wall Street. Put simply, you shouldn’t rely on one investment to reach your financial objectives. No matter how good any investment appears to be now, it can always change or go down in value, and you may suffer a financial setback. For that reason you should not invest in just one stock or one bond, rather, you should allocate your money across several different investments. That’s "diversification".

Asset Allocation

Asset allocation is a little bit different: “put your eggs into different types of baskets”. Asset allocation means that you invest your money into different asset types. Three basic investment types are stocks, bonds, and cash. Each of these investment types has a level of risk and will often perform differently from each other; sometimes better or sometimes worse as economic conditions change.

Professional investors have learned that by allocating investment dollars across different types of investments and holding them for a long time, strong returns are likely while limiting exposure to risk. This doesn’t mean that your investments will never change. Goals change as people do, so it’s a good idea to review your asset allocations at least annually.

Building Your Portfolio

All funds within certain asset classes are not necessarily the same. Within each class of investment, the potential for risk and reward may vary. One stock fund may contain relatively secure shares of long-established, blue chip companies. Another may include shares of newer businesses, which offer potentially higher risks and rewards. The same is typically found in different bond funds, ranging from very secure US government bonds to mid-risk municipal bonds to higher-risk, higher-return foreign bonds. Owning several different funds in each asset class is a plus. Do your homework to select funds that meet your investment strategy.

Rebalancing

Rebalancing your portfolio can help you remain on track. What is rebalancing? For example, assume that you establish an investment strategy of 40% in stocks, 40% in bonds and 20% in money market. If these different types of assets perform as they have historically (stocks outperforming bonds and cash), over a ten-year period your account could shift until you have 60% in stocks, 30% in bonds and 10% in money market. This would likely be inconsistent with your goals and your investment strategy and your investment mix has taken on much higher risk. Rebalancing matches your account balance allocation to your current investment strategy and risk level.

Whatever your retirement planning strategy, long-term goals not short-term performance should be of primary importance. And the more you know about the how’s and why’s of the investments within your retirement savings plan, the more successful you’ll be as an investor.

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