Individuals who avoid risk often view cash investments, such as money market funds and CDs, as worry-free and “safe” options. In today’s volatile markets and amidst recession fears, these investments might be the right choice for some. However, even low inflation can erode the purchasing power of your money. To make progress, your investment needs to outpace inflation.
The reality is that while not all investments are volatile, all investments carry risk. Cash is risky, as holding cash over the long run can limit your portfolio’s ability to grow at a rate commensurate with your future cost of living and can also increase the possibility of running out of money if spending is unchecked. Stocks are risky, as short-term market volatility can cause investors to panic-sell at inopportune times. However, risk shouldn’t deter anyone from investing, as risk and return are two sides of the same coin. You can’t have one without the other. Successful investors learn to manage risk by striking a comfortable balance between the risks they’re willing to accept and the rewards that come with those risks.
Over time, stocks have historically provided investors with the highest long-term total returns. Nevertheless, short-term results can vary significantly.
What types of risk do equity investors face?
- Company and industry risk. A stock’s price may decline if the issuing company performs poorly or is viewed negatively. A downturn in an industry can also impact the price of a company’s shares, even if the company itself isn’t struggling.
- Market risk. Various factors can influence market movement. These may include economic factors, such as anticipated or reported increases or decreases in economic growth or national or international events. Positive news can also boost the market and an investor’s appetite for equities.
- Liquidity risk. Investors may need help conveniently exiting an investment at a reasonable price, a risk applicable to all investments, not just stocks. A forced sale of a holding could result in significant losses.
Bonds are generally perceived as lower-risk investments than stocks. Bondholders should receive their principal and earned income on the bond when held to maturity. However, bond returns are, over the long run, lower than returns on stocks. Bond risks stem from their potential inability to grow assets at a pace sufficient to meet future cash needs. Other risks include:
Default and credit risk. A company or other bond issuer might fail to make scheduled debt payments or repay only a portion of the principal to bondholders. This risk of default is particularly concerning as municipalities grapple with large budget deficits.
Interest-rate risk. Bond prices are sensitive to interest rate fluctuations. When interest rates rise, bond values fall. Consequently, if an investor needs to sell bonds that pay less income than new bonds, they may have to do so at a loss.
The first step in managing risk is determining and maintaining your risk tolerance. Numerous factors, such as age, investment knowledge, and attitude toward risk, will influence your risk-taking decisions.
Once you know your comfort level, you can take appropriate actions to manage the risks you’re willing to accept. For example, establishing an asset allocation strategy and diversifying your investments among stocks, bonds, and cash reserves are crucial steps.
Determining an appropriate asset allocation is challenging, but it is the most important determinant of the long-term success of a financial plan. Utilizing the expertise of professionals can help you navigate that challenge. At Legacy, we specialize in a client-focused method of investing that begins by listening and understanding your investment time horizon, family dynamics, and personal needs and goals. We combine our disciplined investment process utilizing quantitative screening and fundamental analysis with the flexibility to address your unique circumstances and asset mix.
If you are a Legacy client and have questions, please do not hesitate to contact your Legacy advisor. If you are not a Legacy client and are interested in learning more about our approach to personalized wealth management, please contact us at 920.967.5020 or firstname.lastname@example.org.
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