Educational Article
How Should I Save for Retirement?
Chances are that picking the winning lottery numbers will not be your “ticket” to retirement success. Instead, most future retirees will use a more traditional approach, saving and investing.
The terms “saving” and “investing” are often used interchangeably when talking about setting aside money for long-term goals like retirement.
However, saving is about keeping your money safe. As a result, it doesn’t usually generate much interest or earnings. Think of saving as a return of your money – you’ll get back the money you put in.
Investing, on the other hand, is about taking risk with the money you set aside in hopes of earning greater returns. If it works, it helps you outpace inflation and accumulate more. Think of investing as a return on your money – but not one that’s guaranteed.
Anyone can open a savings account to keep money safe, or an investment account to purchase investments such as mutual funds, stocks, bonds, and other securities. But a retirement account is a specific type of account that can hold any of these investments, and offers tax advantages until the money is withdrawn in retirement. Those are covered in the next section. For now, let’s take a quick look at the types of investments you can make.
Basic Types of Investments
Equities
An equity – also known as a stock – represents ownership in a company. Companies sell stock to raise money to fund their business. The purchase of a stock makes you a shareholder in the company. The value of the company may go up or down, affecting the stock price. As a result, the stock may be sold at a profit or a loss. Companies may also distribute profits by giving shareholders periodic payments called dividends.
Bonds
A bond represents a loan made by an investor to a borrower, typically a business or government entity. The borrower promises the debt will be paid back with interest at a specific time. Bonds are typically issued by companies, municipalities, states, and sovereign governments to finance projects and operations.
Cash
Cash and cash equivalents like savings accounts, money markets, and certificates of deposit (CDs) are meant to be low-risk and accessible. Their returns tend to be lower than equities and bonds because they are less risky. This typically makes cash a poor choice for long-term goals because many of the returns won’t even keep up with inflation.
Mutual funds
A mutual fund is made up of money collected from many investors to purchase investments like cash, bonds, stocks, and other assets. They are operated by professional money managers, who allocate the fund’s assets and attempt to produce capital gains or income for the fund’s investors. A mutual fund’s portfolio is structured and maintained to match the investment objectives stated in its prospectus. Mutual funds do not trade on the exchange, but rather the underlying assets do. Fund value is determined at the close of the trading day.
Exchange-traded fund (ETF)
An ETF is an investment that tracks a particular set of equities, similar to an index. It’s similar to a mutual fund but trades just as a normal stock would on an exchange, and its price adjusts throughout the day rather than at market close. ETFs can track stocks in a single industry, such as energy, or an entire index of equities like the S&P 500.
Annuities
Annuities, specifically deferred annuities, are insurance contracts that allow you to save for retirement. A deferred annuity has two phases: an accumulation phase and a payout phase. In the accumulation phase, you contribute to your annuity with either a single lump sum of money or periodically over time. While your annuity is accumulating, you will have an option to earn a fixed rate of interest or choose from a variety of investment choices, depending on your specific contract. When you reach retirement age, you can begin the payout phase. Typically, you receive payouts over a period of time, or you may be able to take a lump sum.
Tips for picking wise investments
A good investment will help you outpace inflation and hit your savings target. A bad investment can be bad news. Read the learning guide on investment strategies to keep your risk mix in check.