When it comes to saving and investing, there's no way to avoid risk. There's
the risk of losing money if the market goes down, which it will from time to
time. There's the risk of playing it too safe and not beating inflation. There's
the risk of not saving enough or not saving at all - and not having the money
you'll need for your future. And there are other types of risk as well. Here are
some ways you can reduce risk:
- Diversify. Put your money into a number of different
types of investment options with different types of investment assets. It
helps reduce risk because your money is spread out across different types of
investments. It's a good idea to diversify your money across cash equivalents,
bonds and stocks. And when investing in a specific asset class, for example,
stocks, it's often smart to include different types of stocks in your
- Invest for the long term. The market will have ups and
downs, but if you invest wisely and leave your investments to grow, you're
likely to get a higher return.
- Be aware of being too cautious. It may make sense for you
to have a portion of your assets in cash equivalent investment options. But
remember that if you invest all your contributions in a "safe" investment
option that earns a 6% annual return, and inflation is 4%, inflation will
erode much of the gains your investment earned.
- Change your investments when you change your long-term
goals. Your financial situation changes at different stages of your
life. Be sure to review your investment mix and your long-term goals on a
regular basis and make changes only when necessary.
The way you distribute your investment dollars among and within different
kinds of assets (cash equivalents, bonds and stocks) is called asset allocation.
It can help you reduce investment risk. Keep these points in mind when choosing
your asset allocation:
- Invest for your risk tolerance and savings goals. If you have low risk
tolerance, as explained in the "Developing Your Portfolio" section you may
want to invest more heavily in conservative cash equivalents and invest some
of your money in bonds. If you are willing to take more risk, you may want to
invest a higher percentage of your assets in stock investment options.
- Know your time frame. If you'll need your savings soon, you may want to
invest in more conservative investment options. But if you won't need your
savings for many years, you may want to take more risk and invest in more
aggressive investment options for potentially greater returns.
Here's a quick overview of risk and return:
Risk is the possibility for gain or loss on your
Return is the actual gain or loss on your
investment, usually expressed as an annual percentage rate.
Choosing the right investment mix is an important step toward reaching your
dreams. The Plan offers a number of different investment types, or "asset
Here's a brief overview of asset classes:
- Cash equivalents or "stable value" investments. These include bank savings
deposit accounts and money market funds 4 which invest in Treasury bills and
short-term securities. They are designed to hold steady in value over time and
are low-risk investments. While the options in this asset class are designed
to be relatively stable and have a place in many portfolios, their returns are
generally low and may not outpace inflation.1
- Bonds or "fixed income" investments. These include both corporate and
government bonds. Although past performance is not a guarantee of future
results, history shows that in the long run, bond investment options grow more
slowly and steadily than stock investment options and generally offer lower
potential returns. Bond investment options can be a useful part of a portfolio
- they help diversify and tone down an otherwise aggressive stock-oriented
portfolio and can help more conservative portfolios stay ahead of inflation.
- Stocks or "equity" investments. These represent ownership in a company.
Stocks are considered the riskiest investment asset class. However, they also
have historically had the highest potential returns over time. For long-term
investors, stocks are often a significant component of their portfolios.
Large-cap stocks. These are stocks issued by companies with
market capitalization of typically more than $5 billion. Many large-cap
companies are called blue-chip companies, a term that comes from the highest
valued chips on a poker table. They are well-established companies, such as GE,
Ford, and IBM and frequently pay steady dividends. While their vast size and
maturity typically makes them less responsive to market changes and often slower
growing, their stability typically can make them well-positioned to weather
inevitable economic downturns.
Mid-cap stocks. These stocks are issued by companies with
market capitalization typically between $1 billion and $5 billion. Historically,
large- and small-cap stocks have received more attention than mid-cap stocks. In
many cases, however, mid-cap companies are established yet responsive, with the
potential for continued, healthy earnings growth. Their larger capitalization
base tends to make them less risky than smaller-cap stocks, though typically
with slightly lower returns.
Small-cap stocks.2 These stocks are issued by
companies with market capitalization typically below $1 billion. Microsoft was
once a small-cap stock and that type of rapid acceleration in earnings and
growth is what small-cap investors are looking for but are not always able to
find. Small-cap stocks can be highly volatile, but they are often viewed as
companies that are on the cutting edge of their industries. Many small-cap
companies effectively respond to market changes; they may also have difficulty
weathering economic downturns.
International stocks.3 These are stocks issued by
companies outside of the United States. Whether you invest in the stock of a
Japanese auto manufacturer, a German design firm, or in more volatile emerging
markets, international stocks can be risky. Political climates may change, and
currency valuations may rise or fall. But international stocks may also give you
the opportunity to diversify into young, dynamic markets that are early in their
growth cycle. International stocks tend to have a high risk and return
potential, and may also have a low or possibly negative correlation (moves in an
opposite direction) with domestic stocks, adding portfolio diversification.
Growth, Value, and Core
Stock managers use different strategies to work toward their goals:
Growth style managers look for companies that are expected
to generate higher-than- average earnings growth over time and reinvest gains
back into the company instead of paying dividends to shareholders. Growth
managers may also be willing to pay a premium price for the stock.
Value style managers look for companies they believe have
strong growth and earnings potential but are currently underappreciated by or
out-of-favor with the market.
A core management style combines both growth and value
Investment options can be actively managed or passively managed. Actively
managed investment options try to surpass the total return of a particular
benchmark index (for example, the S&P 500® Index); passively managed
investment options try to track or match the total return of an index.
Actively managed investment options are run by a
professional portfolio manager, typically with one or more analysts. The manager
engages in regular in-depth research on the individual companies within a
particular area of focus. A variety of research tools, financial analyses, and
personal expertise are used to determine which securities to buy and sell. There
is no guarantee that the portfolio manager will accomplish the goal of producing
higher returns than the benchmark. Actively managed funds tend to have higher
management fees than passively managed funds because you are paying the
investment manager for his or her expertise and research in deciding which
securities to buy or sell, as well as more frequent trading of securities than
with a passively managed fund.
Passively managed or index investment options are designed
to produce similar returns to those that investors would earn if they owned all
the securities in a particular market index. They are called passively managed
because the way an investor's money is invested is determined by the securities
that are included in a particular index, not the discretion of a portfolio
1 An investment in a money market fund is not
insured or guaranteed by the Federal Deposit Insurance Corporation or any other
government agency. Although money market funds seek to preserve the value of an
investment at $1.00 per share, it is possible to lose money by investing in a
money market fund.
2 Equity securities of companies with relatively
small market capitalization may be more volatile than securities of larger, more
3 Foreign investments involve special risks,
including currency fluctuations and political developments.