On Wall Street, risk means the possibility of losing some, or even all, of your original investment. Risk is the chance that your final investment return will be different than what you expect it to be. The risk/return tradeoff is the balance between the lowest possible risk one is willing to assume and the highest possible return one can hope to achieve based on the risk taken.
A common misconception
One common misconception is that higher risk guarantees higher returns. But this may not always be the case. Higher risk may provide the possibility of higher returns, but there are no guarantees.
On the other hand, there are investments that are labeled no-risk or guaranteed. While risk free does not necessarily mean there is absolutely no risk involved, the risk involved is so small that it is generally considered to be nonexistent. Examples are U.S. Treasury Bonds. Unfortunately, even if you invest in these sorts of bonds, the real value of your money will likely drop over time as inflation will eat away at your buying power.
One common way to evaluate risk is to determine the investment’s risk ratio. That is, how much the investment might grow versus how much it might decrease in value.
Just as an investment’s risk factors are constantly in flux, the appropriate risk level for an individual changes too. Depending on your situation in life, your tolerance for risk goes up or down. If your money is invested in stocks, and you are considering buying an apartment soon, it may be prudent to move your assets to a more conservative investment. What would happen if the stock dropped the day before you signed on the house? You wouldn’t have enough money. Is that a risk you are willing to take?
When selecting investment vehicles, look at all of the risks involved. The biggest risk you can take with your financial future is failing to plan properly. And that’s a risk that even the most aggressive investor should avoid.
Douglas Goldstein, CFP®, GFP®, is the director of Profile Investment Services, Ltd. www.profile-financial.com. He is a licensed financial professional both in the U.S. and Israel. Call (02) 624-2788 for a consultation on how to set up your American assets to meet your financial goals. Securities offered through Portfolio Resources Group, Inc. Member FINRA, SIPC, MSRB, FSI. The opinions expressed are those of the author and not those of Portfolio Resources Group, Inc. or its affiliates. Neither PRG nor its affiliates give tax or legal advice.
Published August 20, 2014.