Risk is one of the most important concepts to understand when it comes to investing (AND life in general), but risk in and of itself is a very detailed and complicated topic. There are many different types of risk associated with investments, just as there are many people who have different views of risk, how much risk they should take, and what risks they should actually be taking to achieve their stated investment goals. Since it’s such an integral part of investing, let’s break risk down!
There are many types of risk – market risk, interest rate risk, currency risk, inflation risk, tax risk, economic/political risk, etc., and diversifying your investments (along with proper asset allocation AND location) can help to lower the overall risk of a portfolio over time. NOTE: there is no such thing as a “riskless” investment. Even though that bank CD is FDIC-insured, the current low rates of return means you are subject to inflation risk over time (your money won’t buy as much later on as it could right now). Many people think that stock markets are full of “risky” investments, but they are only thinking about market risk AND economic crashes/recessions/depressions (since we’ve seen more than our fair share of those since the late 90’s, which is a recency bias for sure).
I would argue that with current low retirement savings amounts of many Americans, the 2 biggest risks going forward will be healthcare risk AND longevity risk (you’ll outlive your savings).
Risk can be measured by several methods (and scored in various ways):
- tolerance to it
- capacity to handle it
- requirement to achieve the goal
Important factors tied to risk also include:
- time horizon to reach goals
- current and future savings
- future income needs and those estimated time horizons
Since every person is different, knowing the right questions to ask re: risk (not just tolerance, which is what many mainstream financial articles cover as the main concept of “risk”) AND all of the concepts of risk mentioned earlier is key to helping that person taking the right amount of risk. Also, this person needs to be comfortable with that amount of portfolio risk AND have realistic expectations that the total risk will help them to achieve their goals to accumulate savings, and use those savings over the appropriate lifespan of that particular goal’s need. Otherwise, why invest by the seat of your pants when you can measure in several ways what risks you realistically need to take to get from x to y?
Find an experienced financial advisor who thoroughly deals with risk on a regular basis, works for an RIA firm, earns his/her money from fees (NOT commissions), believes in having an abundance of investment choices for clients, and has the heart & demeanor of a teacher, NOT a salesman, and chances are you’ve found the right financial advisor to help you prepare and plan for your financial goals.
To learn more about Martin Federici, view his Paladin Registry profile.
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