Whether you are investing in a savings account, personal IRA (individual retirement account), or a 401K through your employer, it is important to pick the right investments for you. So how do you know which investment options to choose? There are a few factors to keep in mind when deciding in which types of products to invest: time horizon, risk tolerance, and diversification.
- Time Horizon—This is the amount of time that you plan on investing the money. The way that you invest your money will change throughout your life. For instance, someone who is 20 years old and starting to plan for retirement will invest differently than someone who is 60 years old and within a few years of retirement. When the time horizon is longer, investments should be growth-oriented. When investing for a short-term time horizon, capital preservation should be more of a focus.
- Risk Tolerance—Investing in the stock market comes with inherent risks. While there are no guarantees, there are some investments that are much riskier than others. With greater risk, comes the potential for great reward; however, there is also the potential for great loss. Are you a risk taker or do you like to play it safe? Time horizon can also be a factor in risk. When you have 30 years until retirement, it may make more sense to take a bit of risk; whereas, if you need the money in your account as a source of retirement income within a few years, it may be better to choose more stable investment options. How can you tell if a particular investment is risky or not? Looking at an investment’s beta score is one way. The beta score is a relative measure of risk as compared to a benchmark, such as the S&P 500 Index, and this can be an indicator of which stocks or mutual funds are riskier and which are less risky. A beta score of one means that the investment is in line with the market, or index, used for comparison. If the beta score is higher than one, this indicates that the investment is riskier than the market. A beta score less than one means that the investment is less risky than the market.
- Diversification—Regardless of whether you are investing for college, retirement, or personal savings, there is one golden rule of investing—diversification. Make sure that you don’t put all of your money into just one investment, whether it is a stock, mutual fund, or bond. Spread your money among several investment types and market sectors.