- Investment returns are some combination of interest, dividends and/or capital appreciation.
- The longer you remain invested, the greater your opportunity for higher investment returns.
- Diversifying across many different investment types can help to manage risk.
- To lower your retirement risk, you may need to take on more market risk.
How your investment dollars can grow
At its most basic, investing is about turning a dollar into multiple dollars over time. There are three primary ways to do this:
- Interest. Whether you’ve put your money in a credit union savings account, a money market fund or investment bonds (all examples of fixed income investments), you’re being paid some interest by whoever is holding your money. Generally, the riskier the investment, the higher your interest. For instance, certain types of bonds, which are not insured against loss, may pay higher interest than a FDIC-insured bank savings account. Interest-paying investments like bonds are popular with investors who want to lower their market risk (see below) and generate income for retirement.
- Dividends. Dividends are a way to get regular income from stocks. Larger, more established companies often return a portion of their profits to shareholders in the form of cash dividends. A company’s board decides what percentage of profits to pay out and how often the payments are made. Many retirement investors use dividend-paying stocks to help generate income both before and during retirement.
- Capital appreciation. Also called capital gains, this is the profit you make when you sell an investment for more than you paid. Of course, investments can go down in value too. If you sell for less than you paid, you’ve got a capital loss. Generally, stocks and stock funds are your main sources of potential capital appreciation.
Leveraging the time value of money
With investing, time is money. That’s because the longer you stay invested, the more interest you can receive from fixed income investments and the greater your chance of realizing capital appreciation from stocks. Also, since financial markets can go up and down in value over short time periods, a long investment time horizon helps you balance the inevitable market drops with the equally inevitable market gains.
Here are two ways to use time to your advantage:
- Start saving when you’re young. If you start saving in your 20s and 30s, you potentially have a 30-year or longer investment time horizon to help maximize growth and smooth out market ups and downs. But saving later in life is better than not saving at all.
- Stay the course. Contribute regularly to your retirement savings plans and keep your money invested through good times and bad. As hard as it is to watch your account lose value when times are tough, you’ll have a better chance of realizing long-term growth if you avoid moving in and out of the market by trying to guess when to buy and when to sell.
Investing entails risk—but you can manage it
There are several different types of risk, some tied to stocks and others more associated with bonds. But as a long-term retirement investor, you’re primarily concerned with two kinds of risk:
- Market risk. This is the risk your investments will drop in value causing them to be worth less than what you originally paid. Generally, stocks have the highest level of market risk.
- Retirement risk. If you make very conservative investment choices in an effort to avoid market risk, your investment returns may be too low to generate the growth you need to meet your retirement income needs. That’s high retirement risk.
Market risk and retirement risk are the opposing sides of your investing coin. Taking on more market risk potentially lowers your retirement risk. And the opposite is true, too. But investing is more about trying to make money and less about trying to avoid losing money. It’s a delicate balance. One way to maintain that balance is by diversifying your investing dollars across different types of stocks and bonds so you don’t have all your investment eggs in one risk basket.
Become an educated investor
This article barely scratches the surface of what you need to know to make smart investing decisions. Invest in some home study so you can expand your knowledge and gain the confidence to manage your retirement savings.