Cash or "cash equivalent" instruments such as "money market funds"; usually lower returns with good assurance of payment; more protection for return of initial investment, which is sometimes called "capital preservation".

The investment performance of stocks, bonds and cash has varied considerably over time. Since 1926, the average annual return for stocks has been twice that of bonds and three times the return of cash equivalents.

Since 1981, the returns on stocks have been 30% more than those on bonds and twice that of cash.

This doesn't mean you should run out and put all your money in stocks. Over short periods, these returns fluctuate, and each type of asset outperforms the others at different times. Often, when stock performance is poor, bonds perform well, and vice versa. Of course, there can be no assurance that history will repeat itself.

Some Simple Ways to Diversify - Mutual Funds

Mutual Funds are investment companies that pool money from people like you. That money is then invested in stocks, bonds, money market securities or cash equivalents, or various combinations of these types of investments depending upon the investment objective of the fund.

Mutual funds employ professional managers who are investment experts. They are paid to make investment decisions according to guidelines that indicate what the fund can or will invest in and whether the fund is an "equity fund", "bond fund", "money market fund", or a combination of all three. The guidelines and objectives vary from one mutual fund to another and are explained in the fund "prospectus".

Investing in a mutual fund offers you some level of diversification by investing across industries and companies, and certainly more than if you bought the stock of only a single company. Yet relying on any one fund for all your retirement savings may not provide enough diversification, especially if that fund only invests in one type of investment. If you choose to create your own investment mix, you should consider diversifying among more than one asset class (stocks, bonds and cash) to achieve a balanced level of diversification.

Learning to Live with Risk

It's important to understand that you can create greater retirement risk by not taking some investment risk. True, some investments are more predictable than others, especially over the short term. But, remember, they may not earn enough to win the race against inflation. While other investment choices may have a risk of loss, they also offer the potential for substantially higher returns. It could be said that the higher the investment risk, the lower the retirement risk becomes over time.

Bear in mind that when saving for retirement, short-term predictability on a low-risk investment can result in reaching retirement without enough savings to live on because of lower returns. For most people, retirement is a long-term goal. If that is the case, it shouldn't be saddled with a short-term strategy.

In developing your own risk profile, there are important questions to ask yourself:

How soon will you need the money? If you won't need your retirement money for 15-20 years, you may be able to accept more risk than if you need it in 3-5 years.

Where do your retirement savings fit within your overall financial picture? If your savings and investment plan represents all of your savings, you may not be able to accept much risk. If you have other savings, particularly for emergencies, you may be able to accept more risk.

How do you feel about risk? Does the idea of short-term fluctuation in the value of your retirement savings make you lose sleep? Then consider predictable investments. Does the idea of reaching retirement without enough to live on keep you up all night? Then consider a long-term strategy.