Diversity: Three Types of Mutual Funds

Splitting your money between these three types of funds makes your investments the most secure

The quickest way to build a retirement savings portfolio would be to buy a stock or bond fund and hope for the best. But no one asset class outperforms all the others all the time, so you wouldn't want your retirement to depend on the fortunes of just one investment. Each asset class - growth, fixed income and the cash equivalent - is driven by different sets of economic and financial forces, so it is unlikely that all three would stumble at the same time. Accordingly, you would be wise to hedge your bets by dividing your money among them. To help you formulate your retirement strategy, here is a brief sketch of each asset class.

This class is largely about equities - and that means dealing with the ups and downs of the stock market. Because the market is so volatile, growth investments pose the greatest risk of short-term loss. Conversely, they also offer the best chance for inflation-beating, long-term returns. The younger you are, the less worried you need to be about short-term loss if it means potentially winning long-term gains. At age 30, you might have 70% of your retirement savings invested in growth. At age 60, your stake in growth might be down to 40%.

Growth mutual funds take substantial risks in search of high returns, though they vary in their investment objectives and strategies for achieving growth. Growth-and-income or equity-income funds, for example, invest in dividend-paying stocks that promise both moderate prospects for growth and some fixed-income investments, such as bonds, to boost the total return. Technology funds, on the other hand, invest only in technology stocks, and come with all the pluses and minuses for which tech stocks are known: high volatility, with several years of fat returns often followed by a year or more of steep losses. International funds, meanwhile, invest in stocks outside Canada. Since the world's economies don't move in lockstep, chances are that some foreign markets will be thriving in years when the North American stock markets are down.

Fixed income:
This category basically means bonds - IOUs for money borrowed by either corporations or governments. Bond funds don't have maturity dates like individual bonds do. When one bond in the fund matures, it is replaced with a newer one. Bond funds don't offer the same inflation protection as stocks, but they are less volatile and often do well in years when stocks are doing poorly.

Cash equivalent:
Cash-equivalent funds are generally money market funds, which invest in short-term securities. Their returns tend to be comparable to what you would get from a guaranteed investment certificate (GIC). If you invest in a principal, or capital, preservation fund, you're assured that a core amount of your retirement savings is sheltered from the gyrations of the stock and bond markets.

Once you have decided on an asset mix you're comfortable with - based on your age, years until retirement and tolerance for risk - stick to it. It can be hard to hold on to a growth fund when the market is slumping, and some investors get tempted to dump stocks and seek safety in a cash equivalent. However, the best long-term returns generally go to investors who ride out the bad times with their savings strategy intact, and are already holding growth funds in their portfolio when the next rally takes place.