Risk and Reward in Investing

All investing involves risk. Merriam-Webster’s dictionary defines risk as the “possibility of loss or injury” and “the chance that an investment (such as a stock or commodity) will lose value.”

Although you could lose money, you also could make money. Many things affect the value of an investment, such as market conditions, business decisions, political events, and currency values, to name a few.

The level of risk is tied to the potential level of return. If an investment is not expected to earn as much, it may be considered lower risk. If you take a chance on a potentially volatile investment, you might be rewarded with higher returns for taking that bigger chance. There is no investment product that will be “guaranteed” to earn money, and no product that will offer low risk with high returns.

Even “no-risk” products such as savings accounts and certificates of deposit do have a form of risk. These “safer” products may suffer from inflation risk. This means they may not earn enough interest to keep pace with increased costs of living over time.

It’s important to have savings available for emergency expenses. Financial experts recommend you keep three to six months’ worth of your living expenses in accessible accounts such as savings accounts or certificates of deposit. Money in excess of that amount could be invested.

It’s important to have a mix of risk, and for that mix to be something you can live with. Investment professionals call this “risk tolerance.” In short, this is a measure of how much change in your portfolio you can stand by and watch. If you invest above your risk tolerance, the urge to sell may be too great to withstand.

It helps to build a diversified portfolio. This means you have different types of investments. Not only investments in different companies, but also different industries and in different types of markets. You also can diversify between types of investments such as bonds, stocks, and mutual funds. When one of those types of investments does poorly, another may be doing well. If you have a mix, there should always be something doing well enough to draw upon if you need the money.

It can be challenging to watch the value of your portfolio rise and fall with market changes over the years. One tip that may help: Consider the number of shares instead of the dollar amount. The value of your shares is fluid, and there are no realized gains or losses until you sell the investment. So, instead of focusing on the worth at any point in time, consider how many shares you own. That number of shares will be multiplied by whatever the value is on the day you sell the investment.

Reference: FINRA. The Reality of Investment Risk. Retrieved Sept. 26, 2019, from https://www.finra.org/investors/learn-to-invest/key-investing-concepts/reality-investment-risk

Source: Kelly May, Senior Extension Associate for Family Finance and Resource Management

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