Risk: How Much Can You Handle?
By: Source: AARP.org Date Posted: 2005-03-20 12:09:03
When it comes to investing, the key to success is knowing when to play it safe, and when to risk some of your money on the chance that you could make more.
Insured or Uninsured?
Most Americans play it safe by depositing at least a portion of their money in a savings or a money market account at a bank. No one gets rich from a savings account, but these accounts are good to have. That's because the Federal Deposit Insurance Corporation (FDIC) guarantees these accounts against losses of up to $100,000.
The FDIC doesn't insure the money you invest in stocks, bonds, and mutual funds. Investing in these products can help your money grow at a much faster rate than a typical savings account. But investing is riskier that saving. Just as you can make money when your investments increase in value, you can also lose money if the value of an investment declines.
Risk and Return
Generally, the higher your potential return on an investment, the more risk you will be asked to take. If you buy investments that promise to make you a great deal of money in a short period of time, your chances of losing your money could be high. If you settle for an investment that earns a moderate return over a longer period, your risk will be lower.
Creating a balance between risk and return is part of the art of investing. You might not want to put all your money into safe investments that barely keep up with the rate of inflation. On the other hand, you might not feel comfortable with investing only in risky investments that keep you from sleeping at night. Before you do anything, you must determine how much risk you - and your pocketbook - can endure. Start by asking yourself how much money you can afford to lose in the short term while you wait for good returns over the long term.
Reducing Your Risk
You can reduce your investment risk by diversifying your portfolio. To understand what it means to diversify, think of the world of investing as a collection of baskets. Each basket represents one of the many products, companies, or industries in which you could invest your money. Having a diversified collection of investments simply means not putting all your money in one basket.
Your portfolio won't be diversified if you invest all your money in one type of company, like oil companies. That's because if oil prices fall, your whole portfolio will lose money. Instead, a diversified portfolio might include stock in an oil company, a food company, and a computer company. That way, losses in one type of company wouldn't bring down the whole portfolio. A diversified portfolio might also include investments in small, large, domestic, and foreign companies.
In the same way, you can diversify by putting your money in different types of investment products. For example, you might keep some of your money in cash, put some in stocks, and some in bonds. Designing your portfolio in this way is called "asset allocation."
For More Information
Federal Trade Commission
The Federal Trade Commission has published an article called "Investment Risk" that provides a set of questions that consumers should ask before investing. You can read the article online at the FTC Web site.
URL: http://www.ftc.gov/
bcp/edu/pubs/consumer/invest/inv03.shtm
Forum for Investor Advice
The Forum for Investor Advice is a nonprofit association of financial services organizations. The forum has a brochure called "Understanding and Managing Investment Risk" that you can read online. This brochure discusses the range of risks associated with investing in stocks and bonds. It also gives tips on how investors can control that risk.
URL: http://www.investoradvice.org/
publications/risk_brochure.htm
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