Investing means making choices about what to do with your savings. Risk comes with any investment. Risk can be defined as any “uncertainty” that has the potential to negatively affect your savings.
Investments can be impacted by a number of factors:
- Market conditions (market risk)
- Corporate decisions, like when a company chooses to build a new location (business risk)
- Events within foreign countries, like changing political conditions or the value of currency (political risk and currency risk)
- Whether you can easily sell an investment (liquidity risk)
Risk vs Reward. The level of risk for a particular investment typically correlates with potential return. Reward is the possibility of higher returns. The tradeoff is higher return comes greater risk: as an asset class, stocks are riskier than corporate bonds, and corporate bonds are riskier than Treasury bonds or bank savings products.
Managing Risk. It’s impossible to eliminate risk in investing. But there a couple of things you can focus on that will help reduce possible risk in your portfolio.
- Asset Allocation. By including different asset classes in your portfolio (stocks, bonds, real estate and cash), you increase the probability that some of your investments will increase in value even if others decrease.
- Diversification. When you diversify, you spread your money across different categories of investments. By adding variety to your portfolio, you are increasing the probability that some investments will do well even if others don’t.
Past performance of investments is no guarantee of future results. While asset allocation and diversifying your portfolio may reduce the risk of financial loss, there is no guarantee that an investment will not lose money. Because there are risks, it’s important to understand the various risks associated with specific types of investments.
- Investing in small-cap or mid-cap companies: Small- and mid-cap companies are those with market capitalization below $10 billion. While these investments may have substantial growth potential, they may be subject greater volatility or be less liquid than the securities of larger companies.
- Investing in international securities: International securities typically carry greater risk. These risks include but are not limited to political risk, the depreciation of the currency, and risk associated with varying accounting standards. Investment in emerging markets may result in even greater risk.
- Investing in lower-rated debt securities (commonly referred to as high-yield or junk bonds): These securities involve additional risks because of the lower credit quality of the securities in the portfolio. There is a possible higher level of volatility and increased risk of default with these securities.
- Investing in a single security: Investors who invest a substantial portion of their assets in a single holding may incur share price ﬂuctuations, and the lack of diversification may create greater risk of loss.
The bottom line is that you can reduce your risks using a few sound principles, but you can’t eliminate it altogether. It’s important that, as you approach retirement, you remain cognizant of the risks associated with your portfolio and make wise investment selections.
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