The investment decisions you make today have a huge impact on the amount of income you can generate in retirement.
Investors need to understand the risks and potential rewards of a variety of investments. Use this guide to choose investments that can help you fund your retirement.
Factors to Consider
Before you choose any specific investments, there are several factors that you should consider for any investment option:
- Time horizon: Successful investing requires long-term planning, and you need to know how long you have until your projected retirement date. The more time you have until retirement, the less you need to invest each year to accumulate your targeted amount of retirement assets. If you’re retiring in just a few years, you’ll need to invest far more dollars annually.
- Cost: Investment costs are important because you should not pay high fees for your investments if you’re going to retire and take money out in just a few years. If the fees or sales charges are fairly expensive, make sure that you can hold the investment for five years or more.
- Risk and reward: Every investment carries a level of risk and potential reward, and investors should consider their tolerance for risk. Take a look at the historic price fluctuations in the investment you’re considering. If the average annual increase or decrease is more risk than you’re willing to take, choose a different investment.
Apply these factors to every investment you consider.
Annuities
An annuity is an insurance contract, and these basic annuity concepts are explained on any quality annuities faq sheet:
- An investor pays a premium to an insurance company to create an annuity contract, and the contract pays the investor over a specific time period.
- Annuities are designed to provide income to an investor in retirement.
- The investor can take annuity payments over a fixed period of years, or over the investor’s remaining life.
The advantage of an annuity is that the investor can choose to receive an income payment that he or she cannot outlive. The annuity payments are secured by the insurance company.
Bond Investing
Bonds are debt instruments issued by government entities and by corporations. The issuer pays interest income to the investor each year and repays the original investment amount (principal amount) on a specific maturity date.
If for example, an investor buys a $10,000 5%-fixed rate IBM corporate bond due in 5 years, IBM corporation will pay the investor $500 in annual interest each year, and then repay the original $10,000 principal amount at the end of 5 years. (Please note: these are hypothetical numbers used for easier understanding and are not meant to correlate to current market rates).
Investing in Stocks
Companies raise money by issuing both bonds and stock. While quite a bit more complicated, the very basic essence is that when a firm issues stock the corporation is selling equity, or ownership in the business. Depending on the type of stock purchased, an investor might earn a return if the company pays a dividend, which is a share of the firm’s annual earnings. If the shareholder plays the markets (like the Dow or Nikkei) and the stock price increases, the investor can also benefit by selling the stock for more than the original cost.
Stocks carry more risk than owning an annuity or a bond, because dividend payments are uncertain, and the stock price can decline. As a result, stock investing is suitable for investors who are willing to take more risk to potentially earn a higher rate of return.
Alternative Investment Vehicles
Many investors choose to include alternative investments are part of their total investment portfolio since these investments have different risk and reward factors as compared with stocks and bonds. Alternative investments include private equity, real estate, and commodities, and these investments allow an investor to spread risk over a number of investment strategies.
Do Your Homework
Creating an investment portfolio to fund your retirement requires careful planning and monitoring over a number of years. Make the commitment to understand your investment options to generate the level of income you need in retirement.