Investmentbasics

Once you’ve decided how much to contribute to your plan each pay period, you’ll want to select the investments that are right for you. Many of your investment choices may be mutual funds — professionally managed pools of money that buy, sell, and hold different types of investments. Investments generally fall into four primary categories: capital preservation, bonds, stocks, and balanced.

Capital preservation investments are designed to seek safety of principal with little or no fluctuation in investment value. Investment income is primarily from interest and dividends. Your bank savings account is an example of a capital preservation vehicle. Other examples include:

Certificates of Deposit (CDs) are bank, savings and loan, or credit union instruments that allow you to lock in an interest rate for a specific period of time. If you withdraw your money from the CD before the CD matures, you face an early withdrawal penalty. Most CDs mature in three months, six months, or one year.

Treasury bills (T-bills) provide safety and liquidity because they are backed by the full faith and credit of the U.S. government for full repayment of interest and principal. T-bills are issued with a maturity of one year or less.

Money market mutual funds are professionally managed pools of money that generally invest in high-quality, short-term obligations from corporations and state or federal governments. *

Bond investments are issued by a borrower such as a public entity or corporation that seeks to raise funds.

The borrowing entity promises to repay the face amount by a set maturity date and may pay interest at regular intervals, which can accumulate over time. Bond values may fluctuate with changes in interest rates over time, but this will not change the issuer’s obligations to repay the principal amount at maturity. There are different types of bond investments:

U.S. government bonds are backed by the taxing authority of the U.S. government for full repayment of interest and principal.

Municipal bonds are debt obligations issued by a state or local government entity.

Corporate bonds are issued by corporations.

Bond mutual funds may invest in one or more of these different types of bonds.

Stock investments, often referred to as equities, represent individual shares of ownership in a company. There are different types of stocks including:

Large capitalization (large cap) stocks, also called blue chips, are those of large, well-known industrial and utility companies.

Small capitalization (small cap) stocks are those of smaller, rapidly growing companies thought to have the potential for future growth and profit.

International stocks are those of companies around the world that are issued and traded on foreign exchanges.

Stock mutual funds may invest in one or more of these different types of stocks.

Balanced investments, usually certain mutual funds, seek to provide current income and long-term capital appreciation from a combination of stocks, bonds, and capital preservation investments.

WHAT ARE THE DIFFERENT TYPES OF RISK?

All investments contain some degree of risk. Three important, but very different, types of risk are inflation risk, market risk, and interest rate risk,

Inflation risk — also known as purchasing power risk — is the possibility that the value of your investments will not keep pace with continually rising prices of standard goods and services and your money could lose some of its buying power.

Market risk — also known as principal risk — is the chance that the value of your investment may decline and even cause you to lose some of your principal investment.

Interest rate risk is the risk that the value of a fixed-rate investment will change as market interest rates change. For example, the value of a Treasury bill or bond may decline if interest rates rise. Conversely, its value could also increase if rates fall.

Risk Versus Reward — What To Look For

Different investments have different types of risk, For example...

Capital preservation investments provide you with safety and protection of your principal, but over longer-term periods they may not earn high enough rates of return to outpace inflation.

Bond investments can provide you with steady income, but they are subject to interest rate risk. If rates rise, the value of your bond investment may decrease.

Stock investments generally tend to perform better over the longer term, but over shorter-term periods(less than five years) the value of a stock investment may go way up or way down, and is therefore subject to market risk.

Minimizing Your Risk

Two investment strategies to help compensate for inevitable market cycles are diversification and dollar cost averaging.

Diversification simply means selecting investments from different investment categories to spread out your risk while increasing your opportunity for reward. So rather than risk your money on the success or failure of a single investment, you can share in the potential success of many different investments all at once.

Dollar cost averaging simply means investing an equal amount of money or a percentage of your salary in a group of investments at regular intervals. When prices are higher, your money buys fewer shares. When prices are lower, your money buys more shares. While dollar cost averaging will not assure a profit and does not protect you against loss in a declining market, it will typically reduce the average cost per share of the investment. Your 401(k) Plan is a great way to take advantage of dollar cost averaging. It allows you to automatically contribute a certain percentage of your salary each pay period, regardless of the performance of your investments.