VOLATILITY AS A MEASURE OF RISK

If you are looking for large returns on your retirement investments, you will need to accept more risk. The greater the risk, the greater the potential rate of return.

We often describe risk in terms of volatility, i.e., the amount your investment values fluctuate up and down over time.

Volatility potentially can work in your favor during the accumulation investment phase. It becomes more of a concern when you need to withdraw money, because it may be during a period when the markets and your account values are down.

Historically, stocks tend to have the highest rate of return compared to bonds and cash. Of course, they also have the greatest risk due to their higher volatility. The longer the period of the investment, the lower the volatility, because the long-term growth trend of a stock tends to overcome short-term price drops. If you are close to retirement, you may want to stay away from more volatile investments. However, if your retirement is still many years away, it may pay to invest in these volatile markets. Let's say you invest a lump sum of $100,000 into a highly volatile asset returning an average annual rate of return of 10 percent over 25 years. The year you retire, it suddenly drops by 25 percent. The value of your investment after the drop is $813,000. If you had invested that same $100,000 lump sum into a less volatile investment with a 6 percent return and experienced no 25 percent loss in the final year, you would still only have $429,000 after 25 years. So even with a significant loss, it paid to invest in the more volatile investment.

Now that you understand some of the risks involved in retirement investing, you need to decide what assets you will invest in.