Investing involves risk—and so does not investing. You should understand how both types of risk can affect your ability to achieve your financial goals.
Let’s start with the risks associated with investing. There is no one size fits all investment risk, as different types of investments carry different risks. Here’s a look at three categories of investments and some of the risks associated with them:
Shares – When you invest in stocks or stock-based mutual funds, you run the risk that the value of your investments will decline. Stock prices can fall for a number of reasons – lower than expected earnings, a change in management, changing consumer preferences, etc. Although the historical trend in stocks has been positive, there will always be periods when prices fall. One way to protect yourself against this volatility is to hold stocks for the long term rather than constantly buying and selling, and to own a mix of stocks from different industries and even different countries.
Bonds – If market interest rates rise, the value of your bonds may fall because investors will not pay full price for them when they can get newer bonds with higher interest rates. Another risk associated with bonds is credit risk, which is essentially the risk that the bond issuer will default on its payment obligations, potentially interrupting your interest payments. However, you can mitigate this risk by buying investment-grade bonds, which have the highest credit ratings from independent rating agencies.
Certificates of Deposit (CDs) – Although CDs are generally considered safe because their principal is guaranteed, they carry reinvestment risk – the risk that you will not be able to reinvest the proceeds of a maturing CD at the same interest rate. To protect yourself against this risk, you might own CDs with different maturities. When market rates are low, your longer-term CDs will still pay higher interest, and when market rates rise, you can reinvest the money from your maturing shorter-term CDs in the new, higher-interest CDs.
Now let’s turn to a very different kind of risk – the risk of not investing. And this risk is easy to understand: If you don’t invest, or consistently invest only in the most conservative types of investments, your money may not grow enough to allow you to achieve your important long-term goals, such as a comfortable retirement.
Of course, that doesn’t mean you should never own conservative investments like CDs and some types of bonds. If you’re saving for a short-term goal, like a down payment on a house, a wedding, or a long vacation, you want the money to be there when you need it. So an investment that offers principal protection may be appropriate, even if it doesn’t offer much growth.
But for those long-term goals, you may need to build an investment portfolio that offers growth potential and reflects your personal risk tolerance and time horizon. Over time, your risk tolerance may change. As you approach retirement, you may want to take a slightly more conservative approach—but you’ll always need some elements of growth.
When investing, you cannot eliminate risk, but it can be managed. With this in mind, you should consider a long-term investment strategy that allows for risk but also offers the possibility of return.
— By Tim Schell
Financial Advisor, Edward Jones
Address: 1300 Olympic View Dr., Edmonds
Website: www.edwardjones/com/tim-schell
Phone: 425-775-7817
Email: [email protected]
