(LifeWire) - So you're ready to invest for your retirement. But invest in what? The array of choices you face can be dazzling.
Each type of investment has distinct advantages and disadvantages, and because each tends to behave differently in different types of economic mood swings, any long-term investor's portfolio should be broadly diversified.
Investors can choose from a number of financial tools to gain exposure to the broadest investment categories -- stocks, bonds and cash. Among the most common:
A stock is a partial ownership share in an individual corporation, which means you're buying a direct share in a business's potential success or failure. Owning stocks is a great way to beat inflation, because corporate profits tend to grow faster than inflation. But to mitigate the risk of total loss -- think Enron and Lehman Brothers -- small investors are usually best advised to stick with mutual funds or exchange-traded funds, which offer a quick way to invest in hundreds of companies at a time.
Mutual fund investors pool money to be invested on their behalf by professional managers, who deduct annual fees from the assets. Funds can be set up to invest in stocks or bonds or both. Some are widely diversified -- particularly index funds that mimic market measures like the S&P 500. Others are more narrowly focused on specific industries or countries. Mutual fund shares trade at the end of each market day, after the value of their total investments are added and divided by the number of shares to determine a share price.
An ETF, or exchange-traded fund, is also a basket of investments purchased for a pool of investors. But, unlike a mutual fund, an ETF trades continually through the day like a stock. Some ETFs invest broadly in stocks or bonds. Others invest in specific industries or in the stocks of specific countries or sets of countries, or even in commodities and currencies. All are lightly managed, much like index funds, which tends to make them cheaper to own than most actively managed mutual funds.
A bond is a loan from the investor to the issuing entity, which can be anything from a private business to the United States government. Most bonds are offered with a face-value annual interest rate paid over a set time -- say, 6% per year for 30 years. Bond values tend to remain relatively stable during stock market downturns because they pay a steady income, but they don't rise nearly as high as stocks during economic booms.
In the short run, cash is the safest of all investments. Longer term, though, it tends to be eroded by inflation to a much greater degree than stocks or bonds.
In addition to checking accounts, cash-like accounts include:
- CDs: In October 2008, the federal insurance limit on CDs was raised from $100,000 to $250,000 through Dec. 31, 2009.
- Savings accounts: These also usually are insured, but they pay less interest than CDs.
- Money market funds: These generate interest by investing in conservative securities like ultra-short-term bonds. They may or may not be insured.