Variety is the spice of life and is also a smart investment approach. Let's take a look at the three different types of funds that you could invest in for your 401(k).
Stock funds invest in, well, stocks, which represent an ownership share in corporations. It's important to note that as a fund investor, you own fund shares, not stock shares. Nevertheless, stocks are, by nature, riskier investments but offer the promise of higher returns. Why? Because investors generally get a share of the profits of that business. As the business grows, so does the investment's return. If the business is not doing so well, then neither is your investment. There is the risk I mentioned.
Bond funds are composed of bonds, which are loans made to companies or governments that in turn make regular payments back to their investors. Those payments are made prior to any profit distribution to shareholders, so bonds tend to be lower risk but also have lower returns.
Cash investments are the most stable of all investments in a 401(k). Two examples of these include money market funds and stable value funds. The idea is to preserve the value of the original investment -- that's good. But their returns are so low, they may not keep up with inflation -- that's not so good.
Insider tip:
Often, what does poorly for a couple of years rebounds and becomes the winner for a few years.
When spreading out your money across the three types of asset classes, be more aggressive early in your investment life. As you get close to retirement age, change how much money you have in higher risk investments versus conservative investments (you know, your asset allocation). Think of it like the glide path of an airplane: Gradually dial back the risk as you approach your destination.
Once you land, it's time to concentrate on how to spend your money.