Managing Assesment Risk
You can think of different types of investments as tools to get specific jobs done:
Money market funds, CDs, savings accounts, checking accounts, and similar investments that are designed to keep your money relatively safe and provide modest rates of interest (after subtracting inflation). We say ‘relatively’ because no investment is 100% guaranteed.
Stocks are designed to provide higher rates of growth over the long term, in return for higher risk to your invested money (“principal”). Stocks can range widely in their potential for return and risk, from moderately risky stocks such as U.S. large-company stocks to high-risk stocks such as those of small companies based outside the U.S.
Bonds and other fixed-income investments are generally designed to provide a higher rate of interest income than cash while offering safety of your principal somewhere between that of cash and stocks. As with stocks, there’s a wide range of bonds, from less risky, shorter-term U.S. government bonds that provide lower interest to high-yield corporate bonds that offer more income but higher risk.
Notice what we've been saying about risk and return. There is an iron law of investing: the greater the potential return, the greater the potential risk to your principal. And the lower the risk, the lower the potential return. It’s a trade-off, and there is no getting around it. So be on guard for any claims to the contrary.
All investments have risk of some kind. You can’t eliminate investment risk. But you can manage it.
Managing Investment Risk with Diversification
The saying “don’t put all your eggs in one basket” has a one-word translation in investing: "diversify". By spreading your savings across a number of different investments, you lessen the effect that one poor-performing investment will have on your entire set of investments (your “portfolio”).
Diversification works on many levels. Consider just stocks. Investing in many stocks lowers the risk that one poor-performing stock has on your overall stock performance. Investing in many kinds of stocks—large- and small-company stocks; growth and value stocks; technology and industrial stocks—lowers your overall risk should one of those styles or sectors fail. And investing in stocks around the world lowers your overall risk if the stock market in one country does poorly.
Diversification works the same way with fixed-income investments. Investing across a wide range of government and corporate bonds with different maturities can lessen the impact that poor performance of one bond or type of bond may have on your overall investment.
Finally, diversification works across different kinds of investments. Investing across stocks, bonds, and cash will lessen the impact of poor performance in any one of those investment types. Of course, if you’re not 100% invested in stocks, you won’t get 100% of a rise in the stock market. But you will have taken less risk.
This blending of stocks, bonds, and cash is called asset allocation. Most financial advisors will recommend an asset allocation whose mix is determined by your goals, the time you have to invest, and your tolerance for risk.
Diversified mutual funds and exchange-traded funds (ETFs) offer a simple way for almost all types of investors to benefit from diversification, and from the experience and knowledge of a money manager.
*Diversification does not ensure a profit or guarantee against a loss.
Putting It All Together
Remember the incredible potential of compound growth. Every day that you are invested in the market is one more day your money can work for you.
Consider working with an advisor
A qualified financial advisor can examine your goals and develop a diversified investment strategy to help manage risk and position you to reach your investment goals.
The more you know about investments, the better able you’ll be to protect yourself and make smarter investment decisions.
How Advisors Can Help
When it comes to investing, it is important to focus on your long-term goals and your investment plan.
An advisor can help. Investors who are patient and understand the cyclical nature of financial markets can reap the benefits of long-term market expansion. Investors who shy away from investing due to fear of a market correction could be missing out on market gains.
An advisor can help investors to stay the course and offer objective guidance through an experience that is often emotional.