Whether you have taken receipt of a lump sum or rolled it over into an IRA, you need to make decisions about how to invest your money so it continues to grow. Your first step is deciding how you feel about risk. This will allow you to allocate your investments in a way best suited for your needs.
No matter what type of investor you are, it is important to diversify. That means allocating your money across different types of investments with different levels of risk so that you’re not putting all your eggs in one basket. You may place some of your funds in conservative financial vehicles with a guaranteed rate of return, while putting additional money in aggressive investments that carry more risk but have a possibility of greater returns.
While diversification through an asset allocation strategy is a useful technique that can help to manage overall portfolio risk and volatility, there is no certainty or assurance that a diversified portfolio will enhance overall return or outperform one that is not diversified.
You’ve got plenty of choices in deciding how to invest your IRA or lump sum. Just remember never to invest in a product you don’t fully understand. Here’s an overview of some of the most common opportunities:
Savings Accounts. A savings account, generally offered by a bank, is a good place to store emergency funds and money for short-term use. Your money is generally insured by the FDIC up to $100,000, and you have ready access to your money. The main drawback is low return. The interest rate paid on a savings account is often less than the rate of inflation, so your buying power may be eroded. That may make savings accounts unsuitable for long-term goals.
Money Market Accounts. These accounts, generally available through banks and brokerages, usually earn slightly higher interest than a savings account but still allow easy access to your money. Some banks and financial institutions require an initial deposit of $1,000 or more and limit the number of withdrawals or transfers you can make during a given period of time. Bank money market accounts also are generally FDIC insured. Brokerage houses and other financial institutions are generally not FDIC insured.
Certificates of Deposit (CDs). CDs generally earn more interest than savings accounts with equally little risk, but with less liquidity. Like savings accounts, they are offered by banks and are generally insured up to $100,000 by the FDIC. You agree to keep your money in the CD for a fixed period of time, usually three months to five years. Generally, the longer the term of the CD, the higher the interest rate. If you need to withdraw money before the end of the time period, you’ll pay a penalty.
Fixed Interest Annuities. These contracts, issued by an insurance company, guarantee a rate of interest for a set period of time. Fixed interest annuities also generally have a death benefit. Fixed interest annuities, like CDs, are generally considered low risk and have limited liquidity. Generally, interest under an annuity is not taxed until withdrawn. As with CDs, early withdrawal charges may apply. Also a 10% tax penalty generally applies to the taxable portion of a withdrawal taken prior to age 59½. They also provide an option to receive a guaranteed income for as long as you live. Fixed interest annuities are not federally insured by the FDIC, which means that the annuity’s guarantees are subject to the financial strength and claims-paying ability of the company issuing the annuity. Financial ratings of insurance companies are issued by rating companies such as Moody’s, A.M. Best or Standard & Poor’s. You can check these ratings online, or at your local library.
Most annuity contracts contain exclusions, limitations, reduction of benefits, surrender charges and terms for keeping them in force. Your representative can provide you with costs and complete details.
The decision to purchase an annuity within a qualified plan or IRA should not be based upon the annuity's tax-deferred accrual feature as this is already provided by the qualified plan or IRA itself.
Bonds. Bonds represent loans made by you to federal or local governments or to a corporation with a promise that they repay you with a set interest rate in a predetermined period of time. Bonds are generally considered a less risky investment than stocks, although, if you sell before the bonds mature, their values are affected by interest rate fluctuations and they may be outpaced by inflation. However, if a bond is held to maturity you get the face value of the bond returned to you.
Investments in bonds and other fixed-income securities involve both credit risk and market risk, which includes interest rate risk. Credit risk is the risk that the security’s issuer will not pay the interest, dividends or principal that it has promised to pay. Market risk is the risk that the value of the security will fall because of changes in market rates of interest or other factors. Interest rate risk is the risk that the values of fixed-income securities may fall as interest rates rise. The risk is greater for longer term securities. Lower rated, high yield debt securities generally involve a greater risk of default by the issuer (i.e., higher credit risk). These securities may also be subject to greater market price fluctuations than higher rated, lower yielding debt securities. Independent agencies such as Standard & Poor’s and Moody’s rate bonds in the marketplace according to default risk.
Stocks. When you buy a stock, you become a part owner of a company. In choosing stocks, you look for companies that you believe will do well over time. Be sure to thoroughly research companies you’re interested in, and make sure you understand the potential for profit or loss before you invest. If the company does well, you may receive dividends and/or be able to sell your stock at a profit. Conversely, if the company does poorly and its stock price falls, you may lose some or all of the money you invested. Stocks are generally considered higher risk, but the risk usually decreases with the more variety of stocks you own.
Mutual Funds. A mutual fund pools money from many investors and invests it in various securities such as stocks, bonds and/or money market instruments. The investment company continuously offers new equity shares in an actively managed portfolio of securities. All shareholders participate in the fund's gains or losses. The shares are redeemable on any business day at the net asset value. Each mutual fund's portfolio is invested to match the objective stated in the prospectus.
If you further diversify by purchasing shares in more than one type of mutual fund, your risk may be reduced.
Mutual funds are sold by prospectus, which is available from your registered representative. Please carefully consider investment objectives, risks, charges, and expenses before investing. For this and other information about any mutual fund investment please obtain a prospectus and read it carefully before you invest. Investment return and principal value will fluctuate with changes in market conditions such that shares may be worth more or less than original cost when redeemed. Diversification cannot eliminate the risk of investment losses.
Variable Annuities. A variable annuity offers the same type of diversification as mutual funds, but with an option to offer guaranteed income for life. Variable annuities, like fixed annuities, generally also have a death benefit. In addition, variable annuities may have optional “riders” which for an additional charge, offer guaranteed minimum income benefits, guaranteed withdrawal benefits, including lifetime withdrawal guarantees and guaranteed minimum account balances. The variable annuity may offer a guaranteed fixed interest account, like that offered by a fixed interest annuity, along with an additional five or more investment accounts, each specializing in a different type of investment objective. You choose how much to put in each of the options.
Variable annuities are offered by prospectus only, which is available from your registered representative. You should carefully consider the product’s features, risks, charges and expenses, and the investment objectives, risks and policies of the underlying portfolios, as well other information about the underlying funding choices. This and other information is available in the prospectus, which you should read carefully before investing. Product availability and features may vary by state. All product guarantees are based on the claims-paying ability of the issuing insurance company.
The amounts allocated to the variable investment options of your account balance are subject to market fluctuations so that, when withdrawn or annuitized it may be worth more or less than its original value.
Among the choices that may be available as individual mutual funds or as investment options within a variable annuity are:
Money Market Funds. The assets in these funds typically consist of U.S. Treasury bills, Certificates of Deposit (CDs) and other commercial investments. You’ll find them on the lowest rung of the risk ladder for mutual funds. On the other hand, they also offer the lowest potential for return.
Money market funds are neither insured nor guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although they seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.
Bond Funds. Bond funds may specialize in federal, municipal or corporate bonds with short, medium or long terms. In general, high-grade bond funds are low- to moderate-risk investments, with a few lower grade bond funds categorized on the high-risk side.
Balanced Funds. Blending both stocks and bonds, these funds allow diversification with potentially lower risk than pure stock funds, but also with a lower potential for return.
Index Funds. These funds attempt to mirror the performance of designated market indicies, such as the S&P 500 Index. These indices are commonly used performance measures of the stock or bond market. Index funds invest in most of the same stocks or bonds found in the corresponding index and accordingly, seek to match the performance of that index. Generally, they are adjusted to assume reinvestment of dividends. This middle-of-the-road approach generally puts index funds at the lower end of the risk spectrum for funds with similar objectives.
Growth and Income Funds. Such funds invest in companies believed to have strong growth potential that also have a solid record of paying dividends. Growth and income funds fall in the middle of the risk spectrum.
Growth Funds. These funds invest in relatively stable and established companies, which may or may not pay dividends. Growth funds are considered higher risk, so expect significant fluctuation in share price.
Aggressive Growth Funds. These funds are generally comprised of stocks with greater-than-average potential for growth. Such stocks may include start-up companies, smaller companies or companies in high-risk industries. As a result, these funds have a high degree of risk as well as a high potential for return.
International or Global Funds. International funds generally invest only in stocks from countries outside the U.S., while global funds invest in both foreign and U.S. companies. Investors in these funds take on a higher degree of additional risk, since international issues contain risks not present with domestic issues, such as currency exchange rate fluctuations and different economic conditions, governmental regulations and accounting standards. The potential risks and rewards are very high.
