Investment Basics: Asset Classes and Asset Allocation
There are a variety of investment choices available to you in either the University 403(b) or State 457 tax deferred plans. Select one of the following three basic investment category links for more information:
- Mutual Funds
- Variable-Dollar Annuities
- Fixed-Dollar Annuities
Within these three broad categories, called "Asset Classes", there are many individual investment options offered by the companies who administer the State and University plans. By choosing a combination of these investment options, you can construct a mix or "portfolio" of investment that's right for your goals. The process of creating this mix of investments is called "asset allocation". A variety of resources are available online to help you decide which investments are right for you. You may also want to contact a financial advisor and/or tax professional for assistance.
For information on asset allocation in the 457 Deferred Compensation Plan, see the CMS Deferred Compensation Plan website and the Deferred Compensation Plan Booklet.
For information on asset allocation in the Supplemental 403(b) Retirement Plan, see the following investment company resources:
Creating Your Target Asset Mix - a questionnaire to help you select the mix of investment categories that suits your goals.
Investing Basics - an overview of asset categories with links to helpful information about mutual funds and creating an asset allocation strategy.
Fidelity Freedom Funds - a guide to funds offered by Fidelity that are based on your intended retirement date.
Asset Allocation Evaluator - this online tool will help evaluate your goals and offer suggestions on creating an allocation mix.
Asset Classes - basic information on asset classes and allocation, including a link to the Asset Allocation Calculator which can assist you in determining your risk tolerance level.
A mutual fund is a fund in which an investor's money is combined with the money of many other investors. The total amount of money is invested by a professional manager according to the specific mutual fund's investment objective. Each investor holds a share of the total fund, and is entitled to a portion of the profits of the fund (and, of course, would share in any investment losses).
There are many different types of mutual funds, each with a different objective and with a different potential for growth or loss. Each mutual fund invests in a number of securities, which means that the fund is diversified to help minimize risk. When you invest in a mutual fund, you are actually investing in the securities or other investments held in the fund.
When you decide to invest in a mutual fund, you need to carefully read the fund's prospectus to make sure it meets your objectives. Listed below are four broad categories of mutual funds:
1. Money Market Funds (Short-Term Investment)
Money is invested in short-term securities such as certificates of deposit (CDs), U.S. Treasury Bills, and short-term corporate securities. Investment return from money market funds is due to interest. This type of investment is generally considered low risk with little possibility of a short-term change in value. The long-term rate of return is generally expected to keep pace with inflation, but not to have significant growth possibiliies.
2. Fixed Income Funds (Bonds)
Money is invested primarily in bonds. Fixed income funds differ in the types of bonds they invest in (which may include government bonds or corporate bonds), as well as the average maturity of the bonds (the length of time until the bonds are repaid by the issuer).
This type of investment is generally considered low to moderate risk, with the degree of risk dependent on the type of bonds in the fund and the average maturity. Some fixed income funds seek to minimize risk by investing only in bonds backed by the U.S. Government.
Investment returns are generated primarily by interest earnings, but can include a change in the bond's value in response to a change in general interest rates. The potential long-term rate of return for this type of fund is moderate and again is dependent on the type of bonds held by the fund.
3. Balanced Funds (Mix of Stocks & Bonds)
Money is invested in a combination of stocks and bonds. Balanced investment funds differ in the proportion and types of stocks and bonds they hold. Balanced investment funds are considered to have moderate risk due primarily to short-term changes in stock and bond values. Since bonds are generally less volatile then stocks, they help to moderate the changes in stock values.
Investment returns result from dividend and interest income, as well as change in the market value of the stocks and bonds. This type of investment is generally considered to have moderate to high potential long-term investment returns.
4. Equity Funds (Stocks)
Money is invested in the stocks of corporations. Equity investment funds differ in the types of companies they invest in, including the size of the company and its potential for growth. Equity investments have a significant potential for short-term changes in value. This potential ranges from moderate to very high risk, depending on the type and diversity of stocks in the fund. Funds that hold many different large, well-established companies, for example, have historically been less volatile than funds that hold stocks of smaller, newer companies.
Long-term investment returns range from moderate to high, depending on the types of stocks held in the fund. Investment returns result from stock dividends as well as the growth in value of the stock itself. For example, emerging growth companies may issue no dividends but may show a large increase in the value of the stock itself.
When you invest through an insurance company in a variable-dollar annuity, your money is held in separate accounts and is not part of the company's general assets. It is very similar to mutual fund investments, in that your money is pooled with the money of other investors, and invested according to the investment objective of the variable annuity fund. The same four categories of investments, described above for the mutual funds, also apply to variable-dollar annuities. Again, you must choose among the specific variable-dollar annuity options that meet your needs.
Variable-dollar annuities are also similar to mutual funds in that the stability of the company offering the investment does not affect the performance or safety of your money. The performance of the securities held by the annuity or mutual fund determines the return and risk of the annuity. You would share in the investment's gains (or losses); there is no guarantee on your rate of return.
When you invest in a fixed-dollar annuity, your contributions are invested by an insurance company in securities such as bonds, mortgages, and real estate. When you first invest in the annuity, you are guaranteed a fixed rate of return for a specific period of time, usually six months or a year. Fixed-dollar annuities are unlike mutual funds or variable-dollar annuities because they offer a minimum guaranteed investment return, although you may participate in higher returns.
Fixed-dollar annuities generally have a lower rate of return than other investments, but they are considered lower risk. The insurance company assesses investment and administrative fees, along with a charge for the rate guarantee.
The money that you invest in fixed-dollar annuities becomes part of the general assets of the insurance company. For this reason, the financial stability of the insurance company can affect the performance (and safety) of fixed-dollar annuities.