Investment Risks
& Rewards
Investments with a potential for a greater returns carry a higher risks.
Risk and return go together. If you are not willing to accept more risk,
you're not going to be able to get higher return on your money. The risk
with owning stocks is the short-term fluctuations associated with it. On
average, stocks have declined by 10 percent or more a year every 5 years and
20 percent or more a year every 10 years. Therefore, you must be willing
to accept volatility if you a want to earn a good long-term returns from
stocks. With bonds, risk depends on how good the credit rating on it and how
long until it matures. The lower the credit, the greater the return and
the longer you have to wait for it to matures, the higher the interest.
Risk vs. Reward:
There tends to be a
direct correlation between investment risk and potential reward. Generally
speaking, higher risk tends to equal higher reward potential; lower risk,
lower reward potential.
 High
volatility often accompanies investment risk. Investments whose price is
subject to frequent fluctuations represent a risk to capital. You could
lose money if you should need to redeem or sell when their price is down.
The risk/potential return ratio can vary for different types of
investments. This is true in the case of stocks, bonds, and money market
funds, for example, and applies to different instruments within each of
those categories, as well.
The return potential of
stocks tends to be higher than that of bonds, but stocks also carry a
higher risk. The risk factor of short-term bonds tends to be lower than
that of long-term bonds, but short-term bonds usually offer lower yields
than long-term ones.
Stocks almost
always beat bonds in the long run for most of past century despite wars,
economic crises and global change. You can minimize the risk of
these investments through diversification. Don't put all your money in
just one type of investment or buy just one or two stocks. A good way to
boost the rate of return on your investments without taking on
additional risk is to direct your savings into tax-favored retirement
accounts like 401(k) plan or Individual Retirement account (IRA).
There is little or
no risk to capital associated with government-guaranteed short-term
investments, such as Treasury Bills, but their rate of return tends to be
far lower than that of other investments. There is, however, the risk of
locking oneself into a lower rate of return just before interest rates
rise.
A conservative investor, whose chief concern is safety,
may want to invest everything in U.S. Treasury Bills. An aggressive
investor, whose chief concern is high returns, may want to invest
everything in stocks.
The conservative investor's low-risk strategy will probably yield a much
lower return over the long term. In contrast, the aggressive investor will
probably enjoy a much better yield, but could well encounter large market
swings, such as the market decline in 1987. Also always keep in mind that past performance does not guarantee
future results.
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What is
your risk level?
Think of
risk as the entry fee you pay to invest. You can choose to take a
lot or a little. But you can never avoid it entirely. The payback
for assuming risk is potential return on your investment. No
matter how great a long-term record of an investment such as
stocks and stock mutual funds, you won't receive that average
return of 11 percent if you bail out when the investment turns
sour.
So ask
yourself how much you could stand to see your investment plunge
before taking your money out of that investment. If you are
willing to ride out the short-term volatility of 20% or more, then
you are an aggressive investor. If you can't tolerate short-term
losses, then perhaps you will feel safer with bond funds. |
Next-->>
Benefits of
Diversification and Asset Allocation
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