This is the year you’re getting your money in order. You’ve set goals, have a spending and savings strategy, built an emergency fund, and you’re saving for retirement.
A savings account is good for your short-term goals—the money you’ll need in the next three years. For mid- and long-term goals, you’re going to need something with an engine. That’s what investing does—takes your saving strategy and puts an engine behind it.
- For money you need in three to five years, you have more time to weather market volatility, but you’re still likely sticking to more conservative, fixed income investments like bonds.
- For savings you won’t need for five or more years, you may consider other investments to help spread risk and grow your money, like mutual funds, stocks, exchange traded funds (ETFs), and annuities—depending on your risk tolerance.
You’re already an “investor” if you contribute to your 401(k). But when you’re ready to venture beyond saving/investing in a retirement plan, here are three steps to get started.
Tip: How will you know you’re ready to invest? Read about the four signs to find out.
1. Choose your investment asset allocation.
What’s the difference between investment types and asset classes? A lot centers around risk vs. return. In general, the higher the potential for return (meaning a gain or loss on investment) the higher the potential for risk of loss—and vice versa.
Risk tolerance is how much you can keep the emotion out of investing. Markets typically go up and down, but those short-term market changes can stir both excitement and regret.
Essentially, your risk tolerance and the investments you choose are both important factors, but they aren’t the same thing. Risk tolerance is one factor used to determine your appropriate asset allocation. Risk inherent in assets themselves is then used to craft the investment portfolio.
Some people are more comfortable knowing they could lose money in the short run if there are possible gains in the long run. Others are more conservative, preferring less risk.
2. Mix it up. (Diversify.)
Choosing a mix of investments from various asset classes helps manage overall risk. That’s because some investments tend to increase in value while others decrease in value at various times.
For instance, stocks and bonds tend to move in opposite directions. If the value of your stock funds goes down, the value of your bond funds may increase.
It’s good to choose a mix of different investment options within each asset class. So within your stock investments, you could choose some lower-risk and some higher-risk. This can help you balance stock market volatility.
That’s called diversification. Over long periods, it may help you get a more consistent return. The objective of diversifying is to always have some aspect of your assets able to grow.
3. Adjust your investment mix over time.
In general, it’s good to have less risk as you get closer to your “end goal,” whether that’s retirement or another goal.
That’s because if the market drops, you have less time to recover from losses. Giving up some potential for growth might be worth it in exchange for lower risk.
It’s also a good idea to rebalance your portfolio at least annually. Over time, some investments may grow more than others. After a while, your mix of investments isn’t the same as when you started. That could mean you’re taking on more risk (or less) than you originally intended.
Rebalancing takes everything back to your original mix, but if the change is more in-line with where you want to be, that’s OK, too. Most financial professionals can help you with rebalancing. Some even do it automatically for you.
Mutual funds or pooled investment options help reduce risk
We all hear about people “making it big” on individual stocks. But it’s also easy to lose money on any single investment. It may be intimidating to think about researching and picking stocks or investments with the pressure of potentially losing money.
Mutual funds and other commingled investments (where investors’ contributions are “mutually” pooled) include a variety of investment types. That helps reduce risk.
Investment professionals (portfolio managers) with special training and tools manage mutual funds. That means you don’t have to worry about the everyday decisions involved in picking individual investments within a mutual fund. And in some types of funds, the managers even adjust the mix of investments over time to help you stay on track to reach your goals.
Next steps
Your investments combined with your retirement savings help you reach your financial goals. Log in to your Principal account to review your progress. Don’t have an employer-sponsored retirement account? We can help you set up your own retirement savings.
