retirement
Investing in your retirement

Turning a novice investor loose with an Internet investment account is like leaving a kid alone in a candy store.

Everything looks good and promises such wonderful rewards, but overindulging -- especially in the wrong confection -- can bring with it a world class upset stomach.

To begin, understand all investments have their inherent perks and pitfalls.

Some may promise richer profits. Others come with less risk. That's why understanding how these investments function is such a vital step in crafting the best retirement plan possible.

Most investments can be categorized as stocks, bonds and mutual funds.

Stocks  
Also called equities, stocks are like sports cars: They're fast, they're sexy, and they appeal to buyers that like a little vroom.

Indeed, few other asset classes can match the hidden potential of publicly held stocks. They've been the cornerstone to most retirement accounts because they've boasted higher returns than many other investments, clipping along at an average 10.4 percent a year between 1925 and 2006, according to Ibbotson Associates.

Stocks come in all shapes and sizes -- for every industry imaginable, U.S.-based and overseas alike, and are usually categorized as large-cap, mid-cap and small-cap. The term "cap" is short for "market capitalization," which is computed by multiplying share price by the number of a company's outstanding shares.

"Large-cap stocks tend to be companies that are more established," says Brett Horowitz, a certified financial planner at Evensky & Katz. "Small companies tend to have more risk, and the extra risk you're taking on leads to higher returns."

According to Ibbotson Associates, small caps have grown by an average 12.7 percent annually over the past seven decades. The annual 2 percentage point lead over large caps compensated investors for the extra risk they'd assumed.

Promises and pitfalls

A well-timed investment in computer giant Apple, for example, could easily have set you up for an early retirement. Its stock price languished in the mid-teens in the early 2000s, and in the ensuing five years shot up nearly twentyfold.

With that opportunity for rocket-powered growth, however, also comes greater risk.

Consider the wide-eyed optimists who bet all their savings on a high tech start-up in 1999, only to see their paper wealth -- plus some -- evaporate the following year when the dot-com bubble burst.

To maintain a balanced portfolio, Shashin Shah, a Certified Financial Planner and Chartered Financial Analyst in Dallas, suggests average investors have no more than 10 percent of their total portfolio allocated to individual stocks with 80 percent in stock funds and the remaining 10 percent in bond funds.

Perils of employer stock

Bear in mind, of course, that company stocks do not present excessive risk to your portfolio unless you are overexposed to a particular sector -- or company.

That goes double for those who invest in the stock of their own employer.

Through stock options, employee stock purchase plans and company stock selections in their 401(k)s, many investors hold a disproportionate percentage of their company's stock in their total asset portfolio, leaving them vulnerable.

Should their employer falter, not only is their financial security at stake, but they're likely to lose their job at the same time.

It was a lesson learned by thousands of employees of energy trader Enron Corp. More than 60 percent of Enron's 401(k) retirement funds were invested in the company's stock.

advertisement
replacecontent-tcm:8-106901

Thousands of its employees lost their jobs and life savings when Enron shares plunged from more than $80 a share to less than $1 before it filed for bankruptcy in 2001.

If your retirement plan is currently overexposed to your employer's stock, consider diversifying through your personal investment accounts by adding money to other investments outside of your 401(k) -- in your individual investments, IRAs, etc.

Show Bankrate's community sharing policy
          Connect with us
advertisement
CD & INVESTING NEWSLETTER

Learn the latest trends that will help grow your portfolio, plus tips on investing strategies. Delivered weekly.

Blog

Jennie Phipps

Social Security disability tactics

If you must claim Social Security Disability Insurance, or SSDI, here are some things you need to know.  ... Read more

advertisement
Partner Center
advertisement

Connect with us