What kinds of investments should you choose to build your retirement nest egg? The answer is likely to change with the passing of time.
What is asset allocation?
Putting your money into different investments in different amounts is called asset allocation. The amount you invest in any particular kind of asset depends on (among other things) your time horizon for retirement.
In the short term, cash, certificates of deposit (CDs), and bonds have returns that are the most dependable and the least volatile. But along with lower risk come lower returns. In the long term, equities such as stocks generally have higher returns than other investments. So if you are 30 and have a long time until retirement, you might want to place a large percentage of your investments in stocks. If you are about to retire, you might want to start investing more in bonds and CDs.
The importance of knowing your risk tolerance
The way you allocate your investments also depends on your risk tolerance—in other words, your comfort level with risk. If you have a high tolerance for risk, you are more likely to invest in more volatile investments such as stocks, regardless of your age.
You might also want to reallocate some of your investments upon reaching retirement. For example, you could keep the majority of your investments in long-term, higher-risk assets but move some of your money into short-term, low-risk assets to generate monthly income and decrease volatility.
What the research says
Research has shown that the asset allocation of your investments has a greater impact on your returns than the particular investments you choose, so it is important to consider carefully how to allocate your capital among investment classes as you plan for retirement.
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