The Nature of Risk
When you invest money, you are putting it at risk — all investments can lose money. The key is to gauge your risk, and to not put more money at risk than you are willing to lose.
This is a relative concept. If you have only $10,000 to invest, then putting $9,000 in a high-risk investment means you could lose almost all of your savings. However, if you have a million-dollar portfolio, putting $10k in a high-risk investment would not be considered all that risky, because a loss of $10k wouldn’t obliterate your portfolio.
As you can see, evaluating risk is just as personal as your financial goals. In fact, defining your financial goals — how much money you need based on what you want it to fund — is a main factor in establishing your risk tolerance, as is determining your timeline. If you are young and don’t need your investment money for 10 years or more, you can afford to invest in more aggressive holdings than if you need it in six months. The longer you hold an investment, the more time it has to recover from temporary setbacks.
The final risk consideration is just how much you can stomach when it comes to market volatility. If you get nervous when the market declines and keep checking your portfolio every day, you may be better off with a more balanced portfolio. If you would like a professional evaluation of your risk profile based on these factors, please feel free to contact us. Determining your tolerance for risk, your financial goals and timeline for achieving them are essential first steps to creating a suitable investment portfolio.
In additional to your personal approach to risk, it’s important to understand the various types of risk that exist in investment markets. For example, if you invest in bonds, you need to pay attention to credit risk, measured by independent ratings agencies that determine the viability and financial strength of various bond issuers. Each receives a rating from the agencies based on the likelihood that the issuer may default on bond payments. The higher the rating, the more reliable the issuer. Lower-rated issuers may pay out higher yields on their bonds to make up for the higher risk.
Risk ratings address more than the ability to deliver on financial obligations. Take Russia, for example. Once the war on Ukraine began, the U.S. and other countries imposed widespread sanctions on Russian companies and individuals, basically freezing their ability to do business outside of the country. As a result, Russia’s ratings dropped because its companies lost their ability to trade with global partners, reducing potential revenues and increasing investor risk in those companies — in both stocks and bonds. The Russian government itself was downgraded due to weakened ability to pay debt obligations, as were Russian insurance companies.
There are strategies that investors can deploy — such as diversification, strategic asset allocation and periodic rebalancing — to help mitigate investment risk. But ultimately, investment risk may not go away entirely. Leveraging a small amount of money to potentially earn a higher amount is the basic premise of investing, and it always has the potential to incur risk.
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