Retirement Basics
An egg and money in a bird's nest with at $1 bill in the background
retirement
Stocks, bonds and mutual funds

If you're parking money in a savings account, that's not going to help prepare you for retirement.

Bank accounts, CDs and money market funds may provide safety from loss of principal, but these "cash equivalents" don't boast the higher returns of other investments.

Consider the following riskier alternatives.

Stocks

Also called equities, stocks are 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.

That said, stocks come in many different flavors. They represent all industries, with some based in the U.S. and others overseas. Stocks also come in all sizes: There are large-cap, mid-cap and small-cap stocks. The term "cap" is short for "market capitalization," which is computed by multiplying share price by the number of a company's outstanding shares.

What does that mean?

"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 return," Horowitz adds.

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.

Bonds

When you buy a bond, you're essentially becoming a lender, since bonds are really nothing more than an I.O.U. that's been issued by a government or corporation.

In general, bonds are considered safer investments than stocks. But that's not always true. It depends on the bond you buy. The riskier the bond -- that is, the lower a borrower's credit quality or "rating" -- the higher the interest rate and the more you stand to gain, unless, of course, the borrower defaults. Firms such as Standard & Poor's and Moody's are among agencies that determine if bonds are "junk" status, meaning they carry high risk, or "investment grade," meaning they carry little to moderate risk.

U.S. government bonds are guaranteed by Uncle Sam, so they're the safest around. They mature -- or come due -- in various time periods. Treasury bills generally mature in three months while Treasury notes typically mature within a year. Treasury bonds mature over longer time frames, usually between five and 30 years. Historically, long-term government bonds have returned an average of 5.4 percent annually, according to Ibbotson Associates.

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