Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: MONDAY, March 6, 1995 TAG: 9503090026
SECTION: MONEY PAGE: 6 EDITION: METRO
SOURCE: MAG POFF STAFF WRITER
DATELINE: LENGTH: Medium
Whether you invest in stocks, bonds or money market funds will play a major role in determining how much money you'll have for retirement needs. And a misstep now could cost you a lot of money down the road.
Standard & Poor's, the New York financial services company, recommends shooting for the highest long-term returns and putting all of your money in stocks. Stocks, however, are extremely fickle over short periods of time, with values that can rise and fall dramatically. You could lose some of your money.
Set your sights too low, on the other hand, and you risk earning returns that don't provide much growth potential or protection from inflation's erosion of buying power.
What's the solution? Standard & Poor's recommends that you do what professional money managers do - hedge your bets. Spread your money among different kinds of investments. You may give up some of the rewards of an all-stock portfolio, but your average returns would be more stable.
The key is diversification over several investment options. That's because different investments often react very differently to changes in the economy and the financial markets. While one investment is falling, another may be rising, holding steady or declining less.
A properly diversified portfolio may include a mixture of stocks, bonds and money market investments.
Each of these has different advantages and disadvantages, according to Standard & Poor's.
Money market funds, for instance, carry little risk of losing principal while yields (which are pegged to short-term interest rates) rise quickly when interest rates rise. But the return over time is lower than for stocks and bonds, while a drop in interest quickly leads to lower yields.
Bond funds generally produce higher returns than money market funds over long periods of time, while returns fluctuate less. On the other hand, long-term total returns are generally below stocks, and the value of the fund usually drops when interest rates rise.
Long-term stocks or stock funds usually exceed the return from the other types of investments, providing greater protection against inflation. Disadvantages include greater risk, with possible loss of principal.
So how do you choose among the various options? How much of each kind of investment should there be in your portfolio?
Standard & Poor's says to ask yourself three questions:
When will you need the money?
This is one of the most important factors in determining how you should invest your savings. If you have 10 years or longer before retirement (or until some other savings goal), you can invest more of your money in higher-yielding but riskier investments, such as stocks.
On the other hand, if you will need the money sooner, putting all your money in stocks is not a good idea. You may not have enough time to recover from a market setback.
The shorter your investment time frame, therefore, the greater emphasis you should place on more stable investments such as money market funds. Your returns may be lower, but you can sleep at night knowing that your money will be there when you need it.
How much risk are you willing to accept?
Ask yourself if you have the temperament to withstand big swings in the value of your investments.
If you invest below your tolerance, you could be needlessly settling for reduced earnings. Invest beyond your tolerance, and a sudden drop could scare you into bailing out at the wrong time when the value of your holdings is reduced. You are also likely to miss out on the next upswing.
What is your overall financial situation?
Do you have significant savings and investments outside your retirement savings plan? If so, you can probably afford the risks of aiming for a better return within your plan. Even so, if you are well situated financially, the need for high returns may not be that compelling. You may prefer to stress preservation of your money over high investment returns.
If, however, you have little or no additional savings, refrain from putting all your money in the riskiest investments. If a financial emergency should arise, you could be forced to borrow or withdraw funds after your holdings have dropped in value.
by CNB