Very few people stumble into financial security. For most people, the only way to attain financial security is to save and invest over a long period of time.
Investment Planning: Two ways your money can work for you.
- Interest and dividends. When you invest in a bond or bond mutual fund, someone pays you to use your money for a period of time. If you buy stock in a company that pays “dividends” to shareholders, the company pays you a portion of its earnings on a regular basis. Now your money is making an “income.”
- Price appreciation. When you invest in stocks or stock mutual funds, you buy something with your money that could increase in value. When you need or want your money back, you sell the investment, potentially for a profit.
The reward for taking on investment risk is the potential for greater returns. If you have a financial goal with a long-term horizon, higher-risk assets such as stocks or stock mutual funds may be appropriate. Stable value investments such as cash, FDIC insured CDs or short-term investment grade bonds have lower risk and may be appropriate for short-term financial goals.
Investment Planning: Risk and Return
To “balance” your portfolio’s risk and return, an investor should consider allocating their portfolio among three main asset classes—stocks, bonds, and cash or stable value investments.
To determine the appropriate allocation to stocks, a good rule of thumb is to subtract your age from 110. The answer, or result, is the percent of your portfolio that should be allocated to stocks. For example, a 40-year-old investor should have approximately 70% stock allocation (110 - 40 = 70). By following this rule of thumb, an investor reduces their risk as retirement nears.
By maintaining an allocation to stocks in retirement, an investor reduces the impact of inflation on their purchasing power of their savings.