Local and state governments also issue bonds. Not all are guaranteed, but they're considered relatively safe investments, depending on a government's creditworthiness. That said, municipal bonds have a distinct advantage: Income is generally exempt from federal taxes and sometimes free from state taxes, too.
The usual suspects
- Losing principal. What you invest in goes belly up and you lose a lot or everything. Culprits: individual stocks and high yield bonds.
- Not keeping up with inflation. Prices go up faster than your investments, eroding your spending power. Culprits: Treasury and municipal bonds and cash equivalents.
- Falling short. The investments you choose don't generate enough growth for you to meet retirement goals. Culprits: Treasury and municipal bonds and cash equivalents.
- Paying high expenses. Investment costs make it difficult for fund managers to beat their benchmarks. Culprits: Certain mutual funds, especially those that are actively managed as well as those that have sales loads.
Mutual funds
Think of these as baskets that may contain bonds, stocks and cash equivalents. With thousands to choose from, mutual funds come in a variety of styles. They may hold a single type of asset, such as only domestic large-cap stocks, or a blend of investments, such as a balanced fund with a mix of stocks and bonds.Mutual funds also come in a variety of styles. Some are more risky, others less so, depending on what they're invested in. Index funds are geared to mimic certain indices (such as the Standard & Poor's 500) and they tend to be more tax-efficient and less costly than, say, managed funds that may also have sales charges and other expenses.
Mutual funds enable investors to buy a multitude of assets relatively cheaply. Instead of spending $1,000 for shares of a single company, you could spend the same amount on a fund that holds the same company plus many others. That's a cheap way to diversify your assets and hedge against risk.
Finally, mutual fund companies are generally run by managers who pay close attention to how assets are performing. If you don't have the time or expertise to monitor various investments, then putting money into a mutual fund can be a safer, more practical way to invest.