Racing Towards Retirement
I was seated in the kitchen at work 1 day when the debate considered the 401K plan. Someone said she wanted her profit the lowest risk account but she wasn’t sure which one that was. She was informed by me there was no such thing, that the question was which dangers was she willing to endure. Risk is about possibilities.
Let’s say you are paying all of your bills every month, nevertheless, you aren’t saving anything for future years. The chance, the possibility is that you will not have enough to live on in the foreseeable future. The prize for living this way is now having more income to spend. Bank accounts are insured by the government; if that insurance fails we all have plenty of other problems, so when you put your cash in the bank, it is safe, right?
Kind of. If you put money in the bank it earns an extremely low interest, and you have to pay fees on that interest. By enough time you are done you are not keeping up with inflation. While you have significantly more dollars after many years of saving, your purchasing power decreases. The risk you endure with bank or investment company accounts is inflation risk.
However, your primary amount is safe, meaning bank or investment company accounts are good places for the money you will need in the next few years. You might lose a little purchasing power, but you understand how many dollars you shall have. Bonds are bits of paper (or computer entries) that say you lent money to someone. They entitle one to repayment of that debt, plus interest.
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There are two dangers involved: repayment risk and interest risk. Repayment risk is exactly what it seems like–the risk that the issuing entity will never be able to pay back the loan. Loans are graded by the creditworthiness of the issuing entity. US federal government bonds are considered the soundest; bonds of companies in turmoil, much less so.
Here is where the concept of risk and reward will come in. 1000 to get, could you rather loan money to the US government or to a company that is within financial trouble? If the bonds have the same interest, the choice is simple and that company in financial trouble would never be able to borrow money.