There are two basic strategies that can help you reduce the risk in your retirement portfolio: diversification and dollar-cost averaging. These two strategies can be accomplished by simply saving on a regular basis through a 401(k) plan—you contribute money gradually (dollar-cost averaging) through payroll deductions, and you have the opportunity to invest in different investment funds (diversification).
Diversification
Diversification means don't put all your eggs in one basket. Investment experts say it's smarter to invest in a number of different vehicles. You want to have your money in many different kinds of investments, so that if anything happens to any one of them, it won't be a disaster. Being diversified spreads your risk across various types of investment products.
IMPORTANT NOTE: There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Dollar-Cost Averaging
The strategy of systematically investing a fixed dollar amount over time is called dollar-cost averaging. For example, if you have $1,200 to invest in your retirement program this year, you would invest $100 per month instead of investing the whole $1,200 at the beginning of the year. The benefit of dollar-cost averaging is that it reduces the risk of buying shares at the wrong time—when stock prices are high. The theory is that you buy fewer shares when the price per share is higher and more shares when the price per share is lower. Dollar-cost averaging works in your favor because the average price per share that you end up purchasing is typically lower than the average price of the stock during the same period. This is the principle used when you make regular contributions to your 401(k) plan.
IMPORTANT NOTE: Regular investing does not guarantee a profit or protect against loss in a declining market. This plan involves continuous investments in securities regardless of fluctuating price levels, and you should consider your ability to continue through periods of low price levels.
