5.5 Investment Options

Stocks, Bonds, and Mutual Funds

Stocks represent partial ownership in a company, offering growth potential but higher risk and volatility. Bonds are loans to a company or government, paying fixed interest with generally lower risk than stocks. Mutual funds pool money from many investors to buy a diversified mix of stocks/bonds, offering diversification and professional management, though they charge fees.

Retirement Accounts

401(k) plans are employer-sponsored, often with employer matching, using pre-tax contributions that grow tax-deferred. Traditional IRAs offer tax-deductible contributions taxed at withdrawal, while Roth IRAs use after-tax contributions but allow tax-free withdrawals in retirement. Choosing between them depends on current vs. expected future tax rates.

Risk, Return, and Diversification

Generally, higher potential return comes with higher risk. Diversification — spreading investments across asset types — reduces risk without necessarily sacrificing return. Real estate and CDs (certificates of deposit) offer other options: real estate can appreciate but is illiquid, while CDs are low-risk, low-return, and FDIC-insured with a fixed term.

Key terms

Stock

A share representing partial ownership in a company; offers growth potential but higher risk.

Bond

A loan to a company or government that pays fixed interest; generally lower risk than stocks.

Mutual Fund

A pooled investment of stocks/bonds managed professionally, offering diversification for a fee.

Roth IRA vs. Traditional IRA

Roth: after-tax contributions, tax-free withdrawals. Traditional: pre-tax contributions, taxed at withdrawal.

Diversification

Spreading investments across different asset types to reduce overall risk.

Try an AP-style question

A mutual fund…

1. is a guaranteed bank account
2. pools money to buy many investments
3. is a single company's stock
4. is a type of loan