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Your financial goals influence how much you want to save. Your risk tolerance
helps you to identify the types of investments you're willing to make in order
to reach those goals. Your investment horizon determines how long can save for
those goals.
More than likely, you are already using tax-advantaged accounts to save for your
retirement or perhaps a child's college education. Tax-advantaged retirement
accounts include regular IRAs, Roth IRAs and 401(k) plans. College savings plans
and education savings accounts are tax-favored accounts used to save for
college.
Tax-advantaged accounts can be opened at a bank or brokerage. You buy and sell
mutual funds and other securities with these accounts much as you would for a
taxable account. Since a 401(k) plan is sponsored by your employer, you're
likely to have a narrower selection of mutual funds and other investments to
choose from. Similarly, college savings plans typically offer a limited number
of mutual funds.
If you're buying and selling mutual funds for a taxable account, keep in mind
that income and capital gains are taxed every year. Some investors seek to use
taxable accounts for investments that generate less income and tax-advantaged
accounts for investments that generate more income. You may wish to consult a
financial adviser for advice that is specific to your circumstances.
If you're buying and selling mutual funds for a tax-advantaged account, tax
considerations are less important since taxes on any capital gains and income
are deferred until you begin to use the money.
Inflation: a hidden tax
Inflation cuts into the value of your investments the way taxes cut into your
investment returns. As a result, it is sometimes called a "hidden" tax.
Inflation has averaged about 3% a year over the past decade. This may not sound
like a lot, but consider this: 10 years of 3% annual inflation means that
$100,000 today will only be worth about $74,400 then.
Inflation is bad for stocks and bonds. It raises prices that companies have to
pay for everything from raw materials to labor, squeezing profits. Lower profits
hurt stock prices. Inflation -- or the prospect of it - means higher interest
rates are around the corner. The prospect for higher interest rates sends
markets into a tizzy: Bond prices suffer as investors demand higher coupon rates
to keep up with those paid on newly issued bonds. Stock prices generally fall as
investors look for business costs to increase.
Inflation often results in investors rebalancing their portfolios. They tend to
invest in variable-rate deposits and money market securities when inflation is
higher, taking money out of stocks and bonds. When inflation subsides, interest
rates decline and investors rotate back into stocks and bonds. (We ignore
investments in other asset classes such as real estate or precious metals.)
Two major indicators of inflation are the consumer price index and producer
price index. A yearly increase of more than 3% for either index often portends
higher interest rates since economists often view that much of a climb to be
unsustainable. Other inflation barometers include the level of bond yields,
changes in credit spreads between high- and lower-quality bonds, and moves by
the Federal Reserve to hike the fed funds rate. (This includes a shift in the
Fed's bias towards future rate hikes.)
This information should not be interpreted as financial advice. For advice that
is specific to your circumstances, you should consult a financial or tax
adviser.
» The Asset Allocation Process
» Asset Allocation - Portfolio Diversification
» Asset Allocation - Measuring Your Risk Tolerance
» Asset Allocation - Rebalancing Your Portfolio
» Asset Allocation - Taxes & Inflation
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Asset Allocation - 
