One basic rule of investing is that there’s a direct connection between risk and return, sometimes described as reward. Making investments of varying levels—and types—of risk can help ensure that your portfolio provides both stability and growth. Equally important, combining investments that pose different risks may help you weather economic storms, and can help you protect your principal and take advantage of opportunities for growth.
 You may be willing to take the risk of losing money on stock, stock mutual funds, and other equity investments. That’s generally because you expect equities will increase the value of your retirement account more quickly than less volatile investments. Historically stocks in general, though not each individual stock or stock fund, have provided a return nearly double that of bonds over the long term despite sometimes dramatic short-term losses. Keep in mind that in 23 years since year-end 1925, stocks have lost money.
In contrast, conservative investments that reduce your risk by guaranteeing your principal and sometimes the return you will earn generally offer more modest rewards. The greatest risk is that these investments won’t provide the long-term growth you need to build your account value, especially during periods of high inflation where your rate of return may be less than the rate of inflation. Some of them, such as guaranteed investment contracts (GICs), stable value funds, or fixed annuities may also charge higher fees or impose penalties if you want to move money out because you revaluate the rewards they provide.
It’s important to understand the difference between the investments in your 401(k), from the most risky to the least. Then you can create a portfolio designed to help you meet your goals with the level of risk you’re prepared to tolerate.
Investments generally fall into three different asset classes, which carry different levels of risk and return:
* Source: Stocks, Bonds, Bills & Inflation 2008 Yearbook, Morningstar, Inc. Data is based on the S&P 500 Composite Index for stocks, Salomon Brothers Long-Term High Grade Corporate Index for bonds, and a U.S. Treasury one-bill portfolio for cash. Past performance does not guarantee future results.
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