Four factors should be considered when deciding on your alternative investment strategy. Here are a few thoughts on each.
What is your objective?
Consider the importance of stability of principal, predictability of income, and capital growth. These must be considered against the risk and reward potential of the three categories of investment alternatives. To have maximum stability of principal, you could invest in cash equivalents.
However, your income would be unpredictable due to the variation in short-term interest rates, and inflation could erode your purchasing power.
For higher predictability of income, you could invest in bonds. To do so would require you to take on interest rate risk in the event you need to dip into your savings before some bonds reached maturity. There would also be some exposure to loss of purchasing power through inflation although not as severe as with cash equivalent investments.
You could put your savings in stocks or a stock mutual fund. These choices have provided substantial growth of both income and capital over long periods of time. But, with wide, unpredictable price swings you would be exposed to market risk if you needed to draw from savings in excess of current dividends.
How long do you have?
Time gives you two advantages. If you have time, you can wait out swings in the stock market. And, if you have time, you can often settle for a lower rate of return because the effects of compounding will work more to your favor. Therefore, the time you have before you need to spend your savings and the flexibility, if any, you have on withdrawing money will point you toward particular classes of investments.
What is your risk tolerance?
Investors can be labeled as either conservative, moderate, or aggressive depending on the amount of risk they can comfortably handle. The rule: Don’t take on more risk than you can sleep with. Lying awake nights worrying about your savings is no way to either anticipate or enjoy your retirement.
What are your financial circumstances?
If you have ample savings to cover your needs, you may be able to take additional risk and not substantially affect your financial status. However, if you have limited resources, it might be better to concentrate on less risky investments in order to preserve what you have.
