Is Your Investment Mix Still on Target?
Planning for retirement doesn't stop once you've retired from Consolidated Edison. Even in retirement, which may last 20 or more years, it's important to evaluate your investment mix on a regular basis. Fluctuations in the markets can skew your overall mix of stocks, bonds, and cash investments. Also, your investment time frame and risk tolerance change over time.
Creating and adjusting this mix is an ongoing process known as asset allocation. The beginning of a new year is a good time to assess your current asset allocation to make sure it's still on target to meet your particular financial goals. How you allocate your assets among cash investments, bonds, and stocks is one of the most important factors in determining both the long-term return and price swings of your holdings. Here's a quick review:
- Cash investments are short-term loans to creditworthy borrowers. They are designed to conserve the principal value of your investment and provide income that rises and falls with short-term interest rates. Examples are U.S. Treasury bills, certificates of deposit (CDs), and money market instruments.
Key risk: Because cash investments are conservative, they usually generate the lowest returns and are vulnerable to the effects of inflation.
- Bonds are longer-term loans made to a company, government, or government agency. The borrower, or issuer, agrees to repay the principal after a certain period and also to make regular interest payments along the way.
Key risk: If interest rates increase, bond prices usually fall. (Conversely, if rates fall, bond prices usually go up.)
- Stocks represent partial ownership of a corporation. A stock can increase in value through a rise in the market price of its shares. Many stocks also pay dividends.
Key risk: Stock prices move unpredictably based on the issuing company's performance, market swings, and the state of the economy. Stocks have historically yielded the highest returns over the long term but can also experience prolonged downturns.
How you diversify your savings among the three asset classes affects your long-term returns more so than your individual fund choices. In retirement, you still want to beat inflation with your investments. So consider mixing some stock investments into your portfolio. The accompanying chart illustrates that if you are willing to take on the short-term risk of market fluctuations, you can reduce the long-term risk that inflation will erode the value of your savings.
Average Annual Returns of Asset Classes Before and After Inflation: 1926-2000
Source: The Vanguard Group.
|11.0%||5.6%||4.0%||Return before inflation|
Finding the Mix That's Right for You
The investment mix that is right for you depends on your goal, time horizon, and risk tolerance. The longer your time horizon, the more time you have to weather the ups and downs of the market. As you approach your investment goal, however, you may have less time to recover from market dips. Here's a closer look at these three critical factors:
- Investment goal. For most people the goal is building sufficient assets for a comfortable retirement. Other common investment goals are financing a child's college education or purchasing a new home.
- Time horizon. This is the number of years you have available to invest. It includes the time until you reach your goal as well as the time period when you will be making withdrawals. Your time horizon is the years you will likely spend in retirement.
- Risk tolerance. This is your willingness to endure declines in the value of your investments while you wait for them to return a profit that will help you meet your investment goal.
Risk tolerance is vital in keeping your mix on target as you get closer to your investment goals or as your financial circumstances change. Vanguard's Investor Questionnaire at www.vanguard.com/?inv can help you get started in evaluating your current investment mix by determining your risk tolerance.
You can also call Vanguard® Participant Services at 1 (800) 523-1188 Monday through Friday from 8:30 a.m. to 9 p.m., Eastern time, and ask an associate to mail you the Investor Questionnaire.
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