The world of investing and retirement planning can be a confusing one. On your path to becoming a knowledgeable investor, stop and take a moment to test yourself with these frequently asked questions.

A: For most people, retirement income comes from three main sources: Social Security, employer-sponsored retirement plans and personal savings. These primary sources are often referred to as the "three-legged stool" that supports a person's lifestyle during retirement. If those three sources do not add up to the income you will need during retirement, you may have to add a fourth leg – earned income, or work – as a source of retirement income.

A: The two primary types of employer-sponsored retirement plans include defined-benefit plans and defined-contribution plans. Defined-benefit plans are the traditional pension plans that are funded by employers and provide a monthly cash benefit based on an employee's salary and years of service. An employer with a defined-benefit plan sets money aside annually in a special trust fund. When an employee retires, he or she receives monthly payments from that fund.

With a defined-contribution plan, the employer sponsors a plan, which offers special tax advantages (generally pretax contributions and tax-deferred interest and earnings) to help employees save for retirement. Employees have the freedom to make pretax contributions by salary reduction, and to select the investment options in which they are investing. Employers may match a portion of employee contributions. It is important to note that with a defined contribution plan, the accumulation depends solely on the amount contributed and the performance of the underlying investments.

A: If you invest in savings or investment plans outside your employer-sponsored retirement plan that is considered "personal savings." These investments include traditional financial institution savings accounts, certificates of deposit (CDs), Individual Retirement Accounts (IRAs) and tax-deferred variable annuities.

A: Risk/return trade-off means that an investor must take greater risks to potentially receive a greater return. There is, of course, a higher chance for loss, as well. Risk refers to the possibility that an investment will experience variations in its returns over time. This variation of return is often referred to as "volatility." "Return" refers to the increase or decrease in the value of an investment. Return is usually expressed as a percentage or in dollar growth over time.

A: Asset allocation means investing in assets with dissimilar performance. When investing in assets with similar behavior, whichever direction an investment takes, the others follow. With proper asset allocation, the upward movement of one asset will offset some part of the downward movement of another.

A: Optimization means selecting the most efficient mix of investments in a portfolio. Optimization input requires the investor to clearly analyze and define investment characteristics and goals, determine personal risk tolerance, and figure how much time is left to invest prior to retirement (time horizon). The investor should also identify any investment preferences. Even the most sophisticated optimization program is only as good as its input.

A: The answer to both questions is "no." Transfers among investment options within a tax-qualified plan, unlike transfers among after-tax mutual funds, do not represent taxable distributions, and you will not have to pay taxes until you withdraw the money from your account.

Source: Guide to Social Security and Medicare 2001, William M. Mercer, Inc.