Investment basics
The information provided in the Investment Basics portion of this web site is presented for general educational purposes only and should not be construed as investment advice. Before investing in a particular policy, read the prospectus.
» Categories or "classes" of investments
» Active vs. passive account management
» How investment categories have performed over time
» Risks associated with investing
» Investment strategies to help you reach your goals
Categories or "classes" of investments
Guaranteed or "fixed return" account
Provides safety of principal while the contract remains in force, while crediting a competitive interest rate. Guarantees are based on the financial strength and claims-paying ability of the issuing insurance company.
Equities
When you invest in equities or equity portfolios (also known as stocks or stock portfolios), you are part owner of a company or companies. Equities rise or fall in value according to how attractive they are to buyers and the general conditions of the broad stock market.
Equities can be further categorized into the following classes:
- Large company and small company stocks: Stocks of large, well-established companies with a long earnings history are considered large capitalization equities or large company stocks. Historically, performance of large company stocks has been less volatile than small stocks. Keep in mind though, past performance is not necessarily indicative of future results. That's because large companies often have broader, more diversified product offerings and stronger financial bases. In contrast, small companies often have business risk, stock price fluctuations, increased sensitivity to changing economic conditions, less certain growth prospects and illiquidity, and their stocks reflect this. They often have the potential for fast growth but more risk than larger companies.
- Domestic and international stocks: Equity portfolios that invest primarily in U.S. companies are considered domestic equity portfolios. Equity portfolios that invest primarily in foreign companies are known as international equity portfolios. There are risks inherent in international investing. These include political, social and economic instability, currency fluctuations and differences in accounting standards.
- Value and growth stocks: Value and growth refer to two distinct approaches to investing. Value stocks are stocks that are considered to be undervalued, either according to their book value or their current or projected earnings. These stocks can be those of smaller, less well-known companies and may be more volatile than those of larger companies. Growth stocks are stocks that have shown or are expected to show rapid earnings and revenue growth. Growth stocks are riskier investments than most other stocks and usually make little or no dividend payments to shareholders. Historically, value and growth stocks have tended to show investment growth at different points in the economic cycle, which is why many investors include both of them as a method of diversifying their portfolios. Past performance, however, is not necessarily indicative of future results.
Fixed Income
Fixed income investments are interest-bearing vehicles, the most common of which are bonds. Bonds are essentially "IOUs" plus interest issued by corporations or the government to raise money over a specific period of time. That duration of time can be short-term (1-3 years), intermediate (4 to 10 years) or long-term (10 years or more). Investments in fixed income securities are subject to interest rate risk, and, as such, the net asset value of bond funds will fall as interest rates rise. Generally, the longer the maturity of the bond, the higher the interest rate risk. Bonds issued by institutions that are financially weak will generally have higher interest rates and may have generally higher risk of default than bonds of strong issuers.
Money Market
Money market portfolios invest in the very short-term IOUs of the government and highly rated corporations. Although money market instruments are generally viewed as relatively safe investments, their potential return is fairly low. An investment in a money market portfolio is neither insured, nor guaranteed by the United States Government or any Federal Agencies. There is no assurance that the portfolio will be able to maintain a stable net asset value of $1.00 USD per share, and when redeemed may be worth more or less than original invested.
Active vs. passive account management
Actively managed portfolios pursue a strategy that uses available information and forecasting techniques to seek performance better than a portfolio that is simply diversified broadly. The account option manager attempts to provide value by meeting the account option's objectives while striving to maximize total return and manage risk.
Passively managed portfolios, or index account options, seek to duplicate the performance of a stated market index. The portfolio does not try to give greater total return than the index or provide risk lower than the index. These portfolios may buy all the securities contained in the index or may use sampling techniques that attempt to correspond with the index while holding a fraction of the securities in the index.
How investment categories have performed over time
Investments offer varying levels of risk and return. Generally speaking, the more risk associated with an investment, the greater its potential return over time. Understanding the inherent risks and rewards of each investment type and the underlying investment strategies can help build a diversified portfolio with the objective of earning the highest potential return for the amount of risk assumed.
The graph below demonstrates how risk is tied to performance. Historical performance is never a guarantee of future results.
Source: Ibbotson Associates – International Stocks are represented by Stanley Capital International – Europe, Australia, and Far East (Free) Index. Domestic Stocks are represented by the S&P 500. Diversified portfolio is 50% domestic stocks, 30% domestic bonds, 10% international stocks and 10% U.S. Treasury Bills. Domestic Bonds are represented by U.S. Long term Corporate Bonds. Money Markets are represented by U.S. Treasury Bills. Past performance is no guarantee of future results. The chart is for illustrative purposes only and is not representative of any particular investments.
Risks associated with investing
Part of successful investing is based on understanding and managing risk. In the investment world, risk refers to the elements that determine whether an investment's value or return will be lower or higher than expected. Here's a quick glossary of the most common risks investors face:
- Business risk: The risk specific to a business, firm or property that may cause it to fail as a result of poor earnings from operations or poor management.
- Market or volatility risk: Unrelated issues, including world events, tax laws and the "mood" of the market can cumulatively affect securities prices resulting in changes in stock or bond prices. While market or volatility risk is a significant short-term risk, it becomes less significant with time.
- Diversity risk: This is the risk that goes along with putting all of your "eggs" in one basket. If you own only a few investments, or all of your investments are concentrated in a particular industry or geographic location, you are extremely vulnerable to loss if one of them performs poorly.
- Purchasing power (inflation) risk: Although not a short-term risk, in the long term, the cumulative effect of inflation risk erodes value and reduces returns and purchasing power.
- Currency risk: Shifts in foreign exchange rates can change the dollar value of international investments.
- Interest rate risk: As interest rates rise, bond prices usually fall, lowering the value of bond investments. Conversely, as interest rates fall, bond prices usually increase, increasing the value of bond investments.
- Liquidity risk: When you put money into investments that aren't actively traded, you may not get a fair price if you had to sell suddenly in order to obtain cash or liquid assets.
- Default risk: Bond issuers may default on principal and interest payments. Bonds and bond portfolios carry ratings to help identify this risk. With other types of risk, you have the chance of waiting and potentially recouping your losses. With this type of risk, your loss may be permanent.
Investment strategies to help you reach your goals
All investments carry some risk. But generally, the higher the risk, the higher your potential return. Conversely, the lower your risk, the lower your potential return. Here are some basic strategies for managing risk.
Put time on your side
Money makes money if you give it time. That's the power of compounding. If you start early, compounding can dramatically reduce the amount you need to save between now and the time you retire. Giving your money plenty of time to work means you might find it easier to reach your financial goal.
Take some calculated risks
Your willingness to accept changes in the value of your investments is called your risk tolerance. The amount of risk you can tolerate depends on how long you're going to be investing.
For people with short time horizons — those who need their money in a few months or years — volatility can be a serious risk. The market may be down in value when they want to take their money out. With a longer time horizon, however, the risk of losing principal due to volatility drops. Therefore, if you have a long time to ride out market ups and downs, you may be able to accept more volatility in order to reach your goal. Although asset allocation and diversification do not guarantee against loss, they are methods used to manage risk.
Asset allocation
Asset allocation means spreading your money among different investments (e.g. stocks, bonds, cash). When you diversify investments, you divide them among several types of investment classes with different holdings, management styles and risk. Different types of investments often react differently to similar market conditions. If one investment falls in value, others may be rising, so not all of your money is at risk. Applying the principle of asset allocation may help limit your overall risk and produce more consistent investment returns over time.
Stay in touch with your portfolio
Finally, you can't just create an investment portfolio and forget about it. Your situation may change. Investment markets may change. Your goals may change. For those reasons, you should review your asset allocation at least annually to ensure your portfolio continues to meet your financial goals and make necessary changes to your account.
