The world of investing and retirement planning can be a confusing one. On your path to becoming a knowledgeable investor, stop and take a moment to test yourself with these frequently asked questions.
How can I increase the return on my retirement investment while minimizing my risk?
All investments involve some risk -- the possibility that your principal could shrink or even disappear. Historically, safer investments like certificates of deposit or Treasury bills also tend to offer the lowest rates of return. Low returns carry another kind of risk; over the long term, your savings may actually be losing purchasing power due to the effects of inflation. The secret is to find a balance of historical risk and return that matches your risk tolerance, time horizon and personal investment preferences.
What is risk/return trade-off?
Risk/return trade-off means that an investor must take greater risks to potentially receive a greater return. Risk refers to the possibility that an investment will experience variations in its returns over time. This variation of return is often referred to as \"volatility.\" \"Return\" refers to the increase or decrease in the value of an investment. Return is usually expressed as a percentage or in dollar growth over time. Risk does not mean the risk of loss, but the possibility that over time the returns of an investment will rise and fall.
What is portfolio optimization?
Optimization means selecting the most efficient mix of investments in a portfolio. Optimization input requires the investor to clearly analyze and define investment characteristics and goals, determine personal risk tolerance and figure how much time is left to invest prior to retirement (time horizon). The investor should also identify any investment preferences. Even the most sophisticated optimization program is only as good as its input.
Should I change the mix in my portfolio to respond to market swings?
Unless you are psychic or trying to lose money, the simple answer is no. Timing market swings is a risky endeavor at best -- even for the most sophisticated investor. Many people prefer dollar cost averaging in a soundly diversified portfolio as a long-term way to help manage market swings. This involves a sustained investment program such as payroll deduction at work. Since these savings are invested at regular intervals over time, market swings tend to average out. The key is to stay invested. Staying invested and riding out the portfolio peaks and valleys has historically appeared to be a valid long-term strategy. However, past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor's unit, when withdrawn, may be worth more or less than the original cost.
Note that dollar-cost averaging does not assure a profit and does not protect against loss in declining markets. This type of plan involves continuous investment in securities regardless of fluctuating price levels and investors should consider their financial ability to continue their purchase in the future.
What is asset allocation?
Asset allocation means investing in assets with dissimilar performance. When investing in assets with similar behavior, whichever direction an investment takes, the others follow. With proper asset allocation, the upward movement of one asset will offset some part of the downward movement of another.
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