Fall 2017 Edition

The zero-jargon guide to investing

Don’t let terms like “liquidity” and “debt-equity ratio” keep you from investing in your future. What’s most important is understanding a few key concepts and knowing your goals.

Let’s face it—investing can be a little intimidating. What do the different investments mean, which ones should you choose, and how can you be sure they’ll help provide the money you’ll need to pursue your goals throughout your life? As with anything else, understanding investing takes time. Yet the more deliberately you approach the process, the less confusing and scary it’s likely to seem. Thinking about investing in terms of a few basic concepts can help give you the clarity and confidence you need.

Why you invest

What’s the right mix for you?

Try the interactive Risk Assessment and Investment Guide to find out how much risk you’re comfortable with, and get suggestions about the type of investment mix that might be appropriate for you.

Try the guide

First, think about the goals you’re trying to achieve. More than returns on a balance sheet, these include some of your biggest life priorities, such as retirement, buying a house, educating your children, paying for health care, or even pursuing a passion such as travel.

The investment decisions you make to help achieve those goals will be guided by two key factors:

1) Your time horizon – Whether it’s college in five years or a retirement three decades off, most goals come with a specific time frame before you’ll need the money.

2) Your tolerance for risk – Generally, a longer time horizon enables you to take on more investment risk in hopes of higher returns, because you have more time to recover in the event of a market downturn. Another key factor is how much risk you are personally willing to take.

How you invest

Once you have a clear sense of your goals, the time you have to reach them, and the appropriate level of risk involved, what’s next? Now’s the time to begin planning the best mixture of investments to help you get there—a process known as asset allocation.

Asset allocation refers to the percentage of different asset classes such as stocks, bonds, and various forms of cash that make up your portfolio. Each asset class carries its own unique characteristics and risks.

The scoop on mutual funds

Mutual funds are a collection of stocks, bonds, cash equivalents and other assets that are managed by financial professionals. They can offer convenience—you don’t have to research all of those individual investments yourself—and diversification.

A target date fund, also known as a lifecycle fund, is another type of mutual fund that is designed to become more conservative over time as your target date—for example, the year in which you plan to retire—approaches.

Watch this video to learn more about target date funds >

Stocks, which represent ownership in a company, generally offer the highest potential for return. But stocks and stock funds will fluctuate in value, are not guaranteed, and have historically been more volatile than the other asset classes. That’s why they often carry the greatest risks.

Bonds are loans to a company or government that promise to pay you back, usually with interest, over a period of time. They generally offer modest potential for return, but with moderate risk.

Cash equivalents are short-term loans to a company or government. They’re usually paid back within a year and are readily convertible to cash. Their potential return is generally low, as is their risk.

In general, the longer your time horizon, the more time you have to take advantage of market growth potential and ride out market fluctuations often associated with riskier investments, like stocks. As a goal—such as retirement—nears, you may want to gradually transition towards less risky and less volatile investments. Still, there’s no one-size-fits-all answer, and you may consider meeting with a financial professional to help determine how to balance your mix in a way that suits you and your situation.

Staying diversified

Just as store owners stock their shelves with a wide variety of products to help ensure steady income as the economy and their customers’ preferences change, investors should include a variety of asset classes, regardless of their goals and risk tolerance. This is another key investing concept, known as diversification.

By spreading out your money across a variety of investments, you might be able to offset any losses in one investment or type of investment with gains in another. While diversification doesn’t ensure a profit or protect you against loss, it can help you manage investment risk.

Keep in mind that diversification occurs not just across asset classes (stocks, bonds, cash) but within each class. For example, when it comes to both growth and risk, a stock fund representing large, stable companies may have significant differences from a stock fund representing companies in emerging markets. Watch this video to learn more.

How an asset allocation can change over time

Consider James, a somewhat cautious investor who, in 2008, chose a “moderate” level of risk for the allocation of stocks, bonds and cash in his portfolio. As the stock market marched upward, he did not make changes to his portfolio over the eight-year period. As a result, he’s ended up with a more aggressive stock allocation, exposing him to more risk than he was originally comfortable with.

For example purposes only.

Source: Merrill Lynch Global Wealth Management, July 2017.

Keeping your balance

Once you’ve thought carefully about your investments and selected a mix that you’re comfortable with, don’t stop there. It’s a good idea to periodically take a fresh look at how your investments are allocated—at least annually or as your personal situation and financial goals change. Major life events like marriage, children, a career change or retirement can trigger changes in your risk tolerance and time horizon, which in turn will have an impact on your asset allocation.

Even if your personal situation doesn’t change, markets do. As they fluctuate over time, some of your assets may gain in value or lose value, but not always to the same degree. That can change the balance of asset classes within your portfolio (see “How an asset allocation can change over time,” inset).

Rebalancing can help you bring your portfolio back to the asset allocation you want. You can sell part or all of an asset class that has become overrepresented in your portfolio, then use that money to purchase investments in an underrepresented asset class. You can also restore your portfolio’s balance by increasing deposits to your investment account in order to make additional investments in an underrepresented asset class.

Approaching the future with confidence

All investing involves some level of risk and nobody can predict the future with certainty. Financial markets and the economy, just like your life and family, are bound to change in ways you can’t foresee. Yet having a clear picture of what you hope to achieve, a deliberate approach to investing, and the flexibility to make changes along the way can offer a sense of confidence that you’re on the right path.  

Asset allocation, diversification and rebalancing do not ensure a profit or protect against loss in declining markets.

Investing through your plan involves risk, including the possible loss of principal invested.

Neither Merrill Lynch nor any of its affiliates or financial advisors provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.