Inflation Risk—The possibility that the growth of an investment may not keep pace with the average rate of inflation. In this sense, seemingly “safe” investments that do not outpace inflation—which averages about four percent annually—can be the riskiest over time. In other words, if your investment is earning three percent each year, but inflation is four percent, you’re actually losing money.

Market Risk—The possibility of losing money when the stock market declines. No matter how well a particular company is doing, a drop in the market can affect its stock.

Business Risk—The possibility that a particular company or industry won’t perform as expected. Both stocks and bonds carry this risk.

Interest Rate Risk—The possibility that an investment will decline in value with a rise in interest rates. An older bond, for example, paying a lower rate of interest becomes less valuable than a newer one that pays a higher rate. Higher interest rates also tend to reduce stock prices, because they increase the cost of borrowing for companies.

Currency Risk—Changes in the exchange rate between currencies can affect the value of foreign investments, for better or worse. Note that this type of risk can also affect investments held by a U.S. company issuing stocks or bonds, changing the value of those investments, too.

Balancing Risk and Reward
Generally, the more risk you take, the higher the potential rewards. However, most successful investors don’t always take the highest risk. Nor do they try to avoid it. Avoiding risk altogether is actually a risk itself. Money that is not invested will inevitably lose value due to inflation. So making money through investments requires you to consider the various kinds of risk, and find a balance among a range of investments.

The Importance of Time
To a degree, risk tolerance is a function of time. Investors who have more time to let their investments grow may be able to afford higher risk/higher yield investments than someone who needs the money right away. That means you should carefully consider—and reconsider—the risks you take when choosing investments for your retirement account.

The Role of Asset Allocation and Diversification
Asset allocation is the process of investing your money in various types of investment asset classes, thereby spreading out your investment risk. Diversification takes asset allocation one step further by investing in a variety of investments within those asset classes. Since different investments generally react differently to varying market conditions, asset allocation and diversification work in tandem to reduce the risk you would face if you held only one type of investment in one asset class.  Please keep in mind, application of asset allocation and diversification concepts does not ensure safety of principal and interest. It is possible to lose money by investing in securities.

Here are some of the types of investments you could invest in to achieve asset allocation and diversification:

This means that your account balance will never be less than the amount you previously contributed. However, in order to provide this guarantee, there may be restrictions regarding the amount of money that you may transfer out of the investments in a given year or there may be charges applied to transfer amounts above a specified limit.

Bond Investments
For investors willing to take a little more risk for a potentially larger reward, there are bond or fixed income investments. Bonds are IOUs issued by governments and corporations for money they receive from investors. Governments and corporations promise to pay back these IOUs on a specific date and make interest payments in the meantime. Corporate bonds are issued by private companies to raise capital. Municipal bonds are issued by state and local governments. U.S. Treasury notes and bonds are issued and backed by the federal government.

When you allocate your money to a bond investment, you’re buying a share in a fund/investment that purchases bond instruments.  As the pooled bond investment buys and sells bonds, the value of the portfolio changes, thus fluctuating the income you receive. The market value of your principal in the investment also fluctuates, depending on whether the investment is selling bonds at a loss or a gain. This basically means your shares increase in value when interest rates fall and lose value when interest rates rise. Rates on newly-issued bonds tend to rise when interest rates rise.

Stock Investments
Stocks are shares of ownership in a corporation. A stock’s market value rises and falls depending on how well a company is performing and what its future prospects look like. With a stock mutual fund/investment your money is spread across several different stocks varying in risk. This means your earnings are not solely dependent on the performance of one stock, but several. This advantage, however, does not come without its risks. Since stock funds are dependent on the overall performance of the stock market, stock funds/investments do have the tendency to rise and fall. However, because stock funds/investments invest in many stocks, the price fluctuations and volatility are generally less than individual stocks.

Stock investments have several categories characterized by the capitalization or market value of the companies whose shares they own. Following are several types–broken down by size and strategy–you could choose from if you decide to allocate your money to stock investments.

• Large-cap stocks: Stocks of companies with total market values of more than $10 billion. These stocks tend to fluctuate less in price and are considered less volatile, lower risk investments than small-and mid-cap stocks.

• Mid-cap stocks: Stocks of companies with total market values of between $2 billion and  $10 billion. Historically, these stocks tend to fluctuate in price more than large-cap stocks, offering greater possible reward along with greater risk.

• Small-cap stocks: Stocks of companies with total market values of under $2 billion. Historically, these stocks tend to fluctuate most in price, offering the greatest potential reward and risk.

• Growth Stocks: Invests in large, small, mid-cap companies that have the potential for above average growth in sales and earnings. This type of investment is dependent on a strong manager who has the expertise to tract and locate companies that are destined for success and growth in the coming years.

• Value Stocks: Invests in large, and mid-sized companies that appear to be overlooked or out of favor. These undervalued stocks tend to pay dividends.

How to choose
There are three factors to consider when figuring out how much money you should put into each asset class:

• Your risk tolerance
• Your time horizon
• Your financial goals

Risk Tolerance
Market conditions change on a regular basis. Sometimes they move up, sometimes they move down. That’s the basic premise of investing. But, if you understand your tolerance for risk and keep your investment allocation within this risk tolerance, you’re more likely to develop a sound investment strategy.

There are three types of investor personalities: conservative, moderate and aggressive. Your personality will have a great bearing on the kinds of investments you’re comfortable making.

Time Horizon
Your asset allocation should also take into account your time horizon —the approximate number of years between now and your retirement.

Financial Goals
The final piece of the asset allocation puzzle is knowing what type of lifestyle you expect to live when you retire.  For instance, if you’re hoping to travel the world, you may need a lot more money than someone who wants to stay home with his or her grandchildren. This, in turn, means you may have to invest a bit more aggressively to reach a larger goal and your allocation should reflect that.

Beyond Allocation and Diversification

Invest regularly
Once you have selected your investments, stick to your plan by investing regularly in your company's retirement program. This helps you automatically take advantage of dollar-cost averaging*, which involves investing fixed amounts of dollars at periodic intervals so you purchase more shares of a stock when prices are down and fewer when prices are up.

Invest for the long term
Market prices and interest rates go up and down, but wise investors know that one of the hardest things to do is "time the market"—buy when prices appear to be low, and sell when they seem high. Instead, look to your long-term investment horizon. If you plan on retiring 30, 20 or even 10 years from now, you have time to ride out the inevitable market ups and downs without worrying about temporary fluctuations. Even at retirement, you should consider keeping a portion of your money in investments that have the potential to grow.

^* Dollar-cost averaging and other periodic investment strategies do not assure a profit and do not protect against loss in declining markets. Such a program involves continuous investment in securities regardless of fluctuating price levels of such securities. Investors should consider their financial ability to continue their purchases through periods of low price levels.