If you follow sports, you may know the expression, “You miss 100 percent of the shots you don’t take.” The same is true in the investment world: take no chances, and you’ll achieve no gains. Does this mean you must invest with abandon to make money? Not at all. You generally just need to undertake a sensible degree of risk to make your money grow.
How you allocate your assets depends on your risk tolerance and your long-term objectives. If you have many wage-earning years ahead, you may want to put more into stocks, which historically have the highest long-term rate of return of any investment class. On the other hand, if you’re close to retirement, you may want to begin shifting your portfolio more toward conservative, higher-yielding fixed-income investments. Remember: don’t get too conservative since you have 15 to 20 years to enjoy retirement.
You may choose to invest in stocks, which tend to provide for long-term growth; fixed-rate products, such as bonds or certificates of deposit (CDs); diversified products, mutual funds, and index funds; assets you can access quickly, such as money market accounts; or a variety of other products. Regardless of the products you select, certain risks are associated with investing. For instance:
• Market risk. When you purchase stocks, you’re putting your principal—the amount you initially invested—on the line. If the stocks drop in value, you may lose some of your original investment.
• Interest-rate risk. Like stocks, the value of bonds can drop. If you buy a bond that promises to pay 5 percent and prevailing interest rates rise to 7 percent, the value of your bond will drop.
• Inflation risk. Fixed-rate investments such as CDs offer relatively risk-free principal and a fixed rate of return. However, if your CD gives you a 4 percent annual return and the inflation rate is 4 percent, you essentially earn nothing.
Usually, the more risk an investment has, the greater its return potential. So, when you purchase stocks, you must accept greater risk in exchange for potentially higher returns. On the other hand, by buying “safe” investments such as CDs, you protect your principal—at the risk that inflation will undercut your buying power. To build wealth, you should combine these risks by dividing your investments among several products in a well-balanced portfolio.
The most consequential aspect of investing is to allocate your investments correctly. Studies have shown that 90 percent of investment returns are based on proper allocation of assets, as opposed to “timing the market”—trying to buy low and sell high.
To achieve your long- or short-term financial goals, you may want to consider getting advice from a professional investment manager, who will help you achieve the best balance between risk and return. TPW