Understanding Retirement Investing Basics: Key Terms and Jargon

Saving for retirement sounds simple enough, and your employer-sponsored 401(k) allows you to make convenient contributions to save for your future—but making decisions about how to invest in your plan can be overwhelming if you don’t understand the language used to describe your options. Whether you’re saving in a 401(k), IRA, 403(b), or any other type of retirement plan, we’ve collected some of the key terms and jargon you may see in your plan to help you feel empowered and knowledgeable about your investment decisions.

Four common questions savers have about creating an asset mix

An easy way to think about the concept of a retirement plan, and how you invest in it, is to imagine grocery shopping. The recipe for retirement readiness calls for a variety of ingredients, which are made up of the different types of investments you may choose to put in your shopping cart, or portfolio. Similar to the process of balancing flavors to make a delicious meal, your retirement plan should balance factors like your age and risk tolerance to help you achieve retirement readiness.

Learn more: How Much Should You Save For Retirement?

 

1. What are asset classes?

Asset classes are groups of similar investments that are required to follow specific laws and regulations. These are the "from-scratch" ingredients that go into your shopping cart as you start preparing the recipe for retirement readiness. The following asset classes will make up most of the investment options you’ll choose from when enrolling in your retirement plan:

• • Equities (stocks): This type of financial investment or security represents ownership of a small part of a company, called a share. When you own stock in a company, its value increases or decreases proportionally to the value of the company. These investments can be considered higher risk because the value of a company is likely to fluctuate, but the reward for the risk can be much higher.
  • Fixed income (bonds): Bonds are a loan of investor's money to a company or the government that will be repaid with interest by a set date. This investment is often called fixed-income since the interest payments provide a consistent payout to the investor until the loan is paid back in full (matures). While the interest rates are generally low, their low-risk status can make them an appealing investment option.
  • Cash Equivalents: Short-term investments—such as CDs (certificates of deposit), treasury bills, etc.—are considered cash equivalents.

You may also be interested in: Five Things You Need to Know if You’re Saving in a 401(k)

 

2. How does my retirement plan use mutual funds?

Generally, in your shopping cart, or investment portfolio, you will choose to include a variety of assets spread across different asset classes in order to avoid putting yourself at risk of losing too much value when shifts in the marketplace occur (otherwise called diversification). However, instead of creating a recipe completely from scratch, you may choose to fill your retirement shopping cart with pre-made ingredients to cut down on complication or risk. For example, you may choose to buy pre-made pizza sauce (investing in a mutual fund) instead of buying all the separate ingredients to make your own sauce (individual financial assets like stocks, bonds, etc.).

The following fund types may make it simpler to diversify your retirement portfolio:

• • Balanced fund: A type of mutual fund, sometimes called a hybrid or blended fund, which includes both stocks and bonds (equity and debt) providing diversification and thus earning the reputation of being less vulnerable to volatility in the marketplace.
  • Equity fund: A type of mutual fund which invests primarily in stocks to generate returns, but as a result, tend to be higher risk. 
  • Index fund: A type of mutual fund whose goal is to match the performance of the overall market based on a particular index, like the S&P 500.
  • Stable value fund: A collection of low-risk fixed income investments which are insured, offering protection for investors who are concerned about losing money. The goal isn’t necessarily to gain, but rather, encourages capital preservation.
  • Exchange traded fund (ETF): Operating much like a mutual fund, an ETF tracks a particular index or other asset and uses it to match its performance. The difference is that an ETF is traded like a stock, rather than a traditional mutual fund.
  • Money market fund: A collection of low-risk investments specifically benefitting investors interested in liquidity. Most money market investments mature within a year and offer lower interest rates than bonds and intended to hold a share value of one dollar.

Related: Three Reasons to Increase Your Retirement Plan Contributions This Year

 

3. Are there simple options for a balanced retirement plan portfolio?

If mutual funds are pre-made ingredients, the following types of investment groupings are used by retirement plans like a complete recipe kit instead of a shopping list, giving you the choice to put one pre-balanced package into your shopping cart. These savings options, or asset allocations, include a diversified mix of financial assets and funds based on your retirement date or savings goals.

• • Asset allocation: The term used to describe which investments and in what percentage of the whole money is invested or is directed to be invested.
  • Risk-based asset allocations: Professionally managed investment groupings designed to meet specific risk tolerance preferences of plan participants. It is common for investors to shift from more aggressive investments to more conservative ones over time based on how many years they have before they reach their anticipated retirement.
  • Target date funds: A professionally managed asset allocation or investment grouping designed to gradually shift from higher risk to lower risk (aggressive to conservative) investments based on a chosen target date, often based on an anticipated retirement date.
  • Target risk funds: A professionally managed asset allocation designed to shift investments to continually maintain or target a designated risk level ranging from conservative to more aggressive, rather than a future date.

 

4. How do I make contributions to my retirement plan?

As an eligible participant in an employer-sponsored retirement plan, you and your employer can make contributions to your plan in a variety of ways:

• • Deferral: As an employee, you have the ability to defer part of your pay and invest that money as a contribution into your retirement plan instead. Your deferred pay can be invested pre-tax or (if available for your plan) as a Roth or post-tax contribution.
  • Matching contributions: Your employer can choose to "match” some of your contributions to encourage you to save. These employer contributions are usually a match of a specified percentage of your contribution and is often capped at a specific percentage of your pay.
  • Pre-tax contributions: A pre-tax (also called traditional or tax-deferred) contribution to your retirement plan is a type of deferral from your paycheck before any applicable taxes are taken. A tax-deferred contribution to your 401(k), plus any interest earned on that contribution, continues to grow tax-free until the funds are withdrawn in retirement.
  • Profit sharing contributions: Your employer may choose to make a voluntary contribution to your retirement plan called a profit share. This contribution is not based on how much you contribute and is completely voluntary on the part of your employer, meaning it can vary in amount and be given one year and not the next.
  • Roth contributions: Depending on your plan’s features, you may be able to have any applicable taxes taken from your contribution before your money is invested. This type of deferral is called a Roth (or post-tax) contribution, and this money will not be subject to taxes when withdrawn in retirement. The earnings on your Roth contributions are not taxable as long as you are at least 59½ and your Roth money has been invested for at least 5 years.

Need to rollover 401(k) funds from a previous job? Download this free resource to get started: 401(k) Rollover Overview.

 

Investing in your retirement plan to help you get there

Starting the journey to retirement readiness is an important part of achieving overall financial wellness—and that starts with understanding how your plan works! As you consider the different ways you can invest in your retirement plan and find opportunities for how to save and contribute, don’t forget to take into account your goals for your financial future. Make the most of useful tools available, like our library of Retirement Saving Resources for more information about how to take advantage of all the benefits your retirement plan has to offer.