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You’ve probably heard that investing in the stock market can be compared to a roller coaster ride. To help understand the ups and downs while staying on the ride, let’s review some simple definitions:
Stock Market: Where individual company stocks and bonds are bought and sold. When you buy an individual stock, you are investing in just one company. The value of the stock can fluctuate depending on the health of that company and other market variations. Individual stocks are generally not bought or sold in 403(b)/401(k) plans.
Mutual Fund: A company that brings together money from many people and invests in a collection of stocks, bonds or other assets. Investing in mutual funds is a more diversified approach than investing in individual stocks because you are investing in many different companies through one fund. If the stock of one company decreases in value, you are not as negatively impacted because you are also invested in the many other companies held by the fund, which may have held or increased their value. Mutual funds are typical investment options within 403(b)/401(k) plans.
Mutual Fund Share: When you invest in a mutual fund, you buy a share of that fund. The price or value of a share is determined at the end of every business day and applies to all the shares of that specific fund you currently hold in your 403(b)/401(k) account – even if you previously purchased your shares at a lower or higher price.
Dollar Cost Averaging: An investment technique of buying mutual fund shares on a regular schedule and at a fixed dollar amount, regardless of the share price. You buy more shares when prices are low and fewer shares when prices are high. You are using this technique when you regularly contribute to your 403(b)/401(k) account.
With these definitions in mind, you might compare contributing to your 403b/401k account to a merry-go-round ride. There will still be ups and downs, but dollar cost averaging helps smooth out the wild swings. Here’s how:
In the chart above, the share price of the 4XAMPLE Mutual Fund goes up and down over 12 months like a rollercoaster – $100 buys just two shares in February at the high price of $50 per share, while ten shares can be purchased in April at the low price of $10 per share. But through the process of dollar cost averaging, consistently investing $100 each month over the entire year, a total of 64.6 shares were purchased at an average price of $18.57.
Naturally, the desired outcome of contributing to your 403(b)/401(k) account is that your original investment will have increased by the time you retire. You can be reassured if you keep in perspective the ups and downs of the investment ride throughout your career – not all down is bad, not all up is good – and understand that consistent contributions throughout your career can be key to your success. Furthermore, you may have access to expert guidance from Financial Engines and Fidelity Investments to ensure that your 403(b)/401(k) investments are optimal for your risk tolerance and retirement timeline. You can learn how to access these resources by searching HR Connect via the intranet.
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