Key takeaways
- Historically, stocks have offered higher returns than many other investment types but with higher market (short-term) risk.
- Bonds, which generally are less risky than stocks, provide regular interest payments, making them a good choice for a tax-deferred retirement plan.
- Annuities can offer you a steady stream of retirement income without the risks of stocks and bonds.
- Different investment classes have varying levels of risk and return potential, so diversifying across some or all types may give you more investing flexibility.
Stocks
Whether you buy stock in U.S.-based companies or firms domiciled outside the U.S. (international stocks), you assume an ownership stake and get to share in the company’s earnings. Historically, stocks have offered higher returns than bonds and many other classes over long time periods, although they generally carry higher risk, meaning their value can go up and down a lot over shorter time periods. (Some international stocks may have more risks compared to many U.S. stocks.) For this reason, stocks are often used as the foundation of a long-term retirement investment strategy.
Also called equities, U.S. and international stocks are categorized in many different ways. A well-diversified investment portfolio may include some or all of these types:
- Large Cap Stocks — Cap is short for capitalization, an investment term used to indicate the relative financial size of a company. Large cap stocks are the big industry leaders, often called “blue chips,” with market caps over $10 billion. These well-established, stable companies tend to be less risky than small caps.
- Mid-Cap Stocks — These medium-sized companies have market caps between $2 billion and $10 billion. They often share some of the risk and return characteristics of both large caps and small caps.
- Small Cap Stocks — The smallest companies have market caps under $2 billion. Their prices can be more volatile (meaning they are riskier) but they also have the potential for faster growth and higher returns.
- Value Stocks — Value stocks tend to be priced lower than what they’re worth. Think of them as being on sale. There are many reasons why a company might be value priced. Growth may have slowed. Or the firm may have had some temporary bad luck or be in an industry that has fallen out of favor. Value stocks often pay above-average dividends (a return of profits to shareholders through cash payments), which can add some tax-deferred income to a retirement portfolio.
- Growth Stocks — Growth companies tend to be growing earnings faster than the market as a whole. The excitement surrounding a fast growing stock can drive up its price (sort of the opposite of a value stock). These companies pour profits back into the business so they rarely pay dividends. If you expect to stay invested for a long time, growth stocks offer the potential for higher returns, although with higher levels of short-term risk.
Bonds
An investment bond is basically a loan. When a corporation or government agency needs to raise funds, they get investors to loan them money (by buying bonds) in exchange for a promise to pay the investors fixed interest payments for a certain period of time. At the end of the time period, the investors get their original loan amount (the principal) back.
Like stocks, there are different types of bonds with different risk levels. Since bonds pay out regular interest, they may be especially suited to a tax-deferred retirement plan like a 403(b) plan because you don’t have to pay taxes on the interest until you withdraw the money. Generally, bonds have lower overall risk levels than stocks.
Annuities
This type of retirement investment is a contract with an insurance company. You pay premiums to the company and they agree to pay you a steady stream of income for a certain number of years, or the rest of your life, starting at some point in the future. Investors often use annuities as a way to get guaranteed returns without worrying about the type of market risks you get with stocks. Annuities come in many variations and can be quite complex. Speak with a financial professional to see how this option can work for you.
The bottom line
There are many other investment options besides the few listed here. Since they all offer slightly different levels of risk and return potential, it makes sense to spread your money across many classes. This strategy, called diversification, can help you manage risk and aim for the long-term investment returns you need to reach your savings goals.