3 Fundamental Investments You Need

Posted on May 23, 2014 at 10:56 AM PDT by

A safe, sound retirement investment plan is made up of a lot of building blocks, literally thousands of investments at a time. But it can be broken down into three general categories, each with its own strengths and uses.

The goal of a long-term investment is to double predictably. By doubling periodically, you get the compounding effect. Money makes more money on your behalf with no need to add extra dollars.

Compounding is powerful. If you invest $10,000 in a prudently run portfolio, you should expect it to become $20,000 in about 10 years or less at a market rate of return.

What happens next is the interesting part. That $10,000 has become $20,000, but over the next 10 years it turns into $40,000.


Add 10 more years and the balance is $80,000. If you manage to keep it invested for 40 years, the total is now $160,000. That’s if you put in $10,000 and never add another dime. Imagine the result from saving $10,000 each and every year you work.

How do you get there from here? By owning investments, and you really only need to think about three. They are:

1. Stocks

Equities are the main driver of growth in a portfolio. They come in all sizes and shapes, ranging from large blue-chip firms down to fast-moving small caps. Large-cap foreign equities are part of the mix, as well as emerging markets stocks.

The reason you want to own stocks is that they tend to appreciate more rapidly than most other investments. The downside is volatility. Valuations can be sky-high one year and fall catastrophically the next.

You can avoid the worst of this effect by owning stocks through index funds and index-style ETFs. Owning entire markets gives you exposure while limiting the risks posed by putting too much money into a small number of firms or just one sector of the economy.

2. Bonds

Bonds are the major complement of a stock-driven portfolio, the ballast that keeps the balloon in check whatever the turbulence in the markets. Bonds also pay a steady income, money which can be reinvested back into the portfolio, the same as you would income from dividend-paying stocks. Foreign bonds also play a role.

The real value, however, comes from the ability of bonds to slowly nail down long-term gains earned by a portfolio. As you get older, the mix of bonds to stocks should begin to tilt in favor of bonds.  Doing so greatly reduces the likelihood of a last-minute stock market decline taking your retirement down with it, forcing you to work years longer than you had planned.

3. Alternatives

Most portfolios stop at stocks and bonds, but consider adding in small slices of less-common investments, such as real estate and commodities. They can be owned, as can bonds and stocks, through ETFs in order to reduce concentration risk.

Why own them at all? Because the less-traveled corners of the market are where the money goes when fear runs rampant in the stock and bond markets. Rebalancing is key. If a sudden push into real estate raises the value of your holdings, it quickly becomes time to cash out some of those gains and reinvest in the other parts of your portfolio.