The sheer number of options available to plan for retirement, and their confusing names and acronyms, can make you want to avoid the process altogether. For instance, IRAs are a type of investing tool that allow you to set aside money specifically for retirement, but they do not come in a one-size-fits-all package. There are several types of IRAs you can choose from based on your situation. Some are tax deductible, and others are not, but all have tax and other related benefits.
On the other hand, 401(k)s are usually offered to you by a company you work for, with many companies matching a certain percentage of your 401(k) contributions. Your 401(k) is tax deductible, meaning the money for your 401(k) is taken out of your paycheck before it is taxed. But once you finally decide whether you need an IRA, 401(k) or both, you are likely to find yourself suddenly faced with a more menacing decision: Should you invest in a money market account? Stocks? Bonds? How much in each?
If you find yourself feeling cornered and maybe a bit confused when it comes to these terms, you are not alone. The good news is that understanding the differences between them is not nearly as difficult as you might initially think. With a little guidance you can learn the differences between money market accounts, stocks, and bonds and decide how your portfolio should be balanced based on your retirement goals and desired risk profile.
What is a Money Market Account?
A money market account (MMA) is an extremely low-risk but also low-return fund option. It holds securities that are generally short-duration or investments that are fixed-income and extremely liquid. People who are risk averse often consider this option for their 401(k) and IRA. However, the returns you receive with MMAs are often negligible and will not result in significant retirement income; they are used less as an investment and more as a place to securely store cash.
What is a Stock?
When you invest in stock, you are buying a portion (or share) of a company or corporation. That is why people who buy stocks are known as shareholders. Owning a stock, therefore, gives you a stake in a company's assets and earnings. The more shares you buy of a company, the greater you can benefit from its financial performance.
If the company performs well in the stock market, the value of the company's stock will rise, meaning your shares will increase in value. However, the opposite is also true. If the company does not perform well, the stock price will fall, and your account will decrease in value. While more risky than MMAs and bonds, stocks can yield greater returns than either.
What is a Bond?
When a corporation or the government wants to borrow money, it sells bonds. Essentially, the person or entity who buys the bond is lending money to the corporation or government for a period of time. In turn, they are promised that the borrower (or the party selling the bond) will repay them by a certain date. When it matures, the bond is repaid to the purchaser with interest. Bonds can also be bought and sold as their value changes.
The key to understanding the difference between stocks and bonds is to know that stocks represent equity while bonds represent a debt obligation. Equity can both evaporate instantly and generate a high rate of return, so stocks are volatile and risky. Debt cannot be evaporated, except through a lengthy court process, and generally does not generate a high rate of return, so bonds are stable and have low risk.
While this general information should give you what you need to know to begin apportioning your portfolio, it is only scratching the surface of these three financial instruments. If you need help making a deep dive into any of these topics, GuidedChoice is here for you. We can help you define a strategy that can bring you closer to achieving the retirement you have always dreamed of. Through our 401(k) advisory service, we can create a personalized and diversified portfolio for you and help you manage it, get you closer to your goals. If you are looking for an IRA, our managed IRA creates personalized portfolio to reach your goals, relieving you of the stress of trying to go at it alone. Learn more today.