Tuesday, June 12, 2012

No Investment is Risk Free

I’m often asked for the secret formula to successful investing. I think Peter Lynch said it best when posted the question: “How do I make money in the stock market?”  His answer was, “The key to making money in stocks is not to get scared out of them.”  In addition to not being scared out of the market, you can be rewarded for buying more shares when other investors are selling. Another key to investing is understanding all the different types of investment risks.  Even guaranteed investments like CDs that are FDIC insured carry risk.  CDs are subject to inflation risk.  If you earn 1%, inflation is 2% and you are in the 30% tax bracket.  Your CDs have a negative 1.3% rate of return.  That’s what we call in the investment business “going broke safely.”  The moral of this story is that if you are looking for an investment without any risk, stop looking.  You won’t find one.
All investments have risks – just different kinds and degrees.  So it’s important to know what the specific risks are and how they can affect your portfolio.**
Market Risk: Stock market ups and downs are unpredictable.  So market risk – the possibility that investments will lose value because of a decline in the securities markets – may be the risk you about first.  Choosing an appropriate investment strategy and sticking with it may help your portfolio survive a volatile market.
Interest Rate Risk: You may think you can avoid the uncertainty of the stock market by investing in bonds.  But bond investments have their own risks.  Changes in interest rates affect bond prices.  When rates rise, prices of existing bonds fall because older bonds are paying less interest than newly issued bonds.  Holding a variety of bonds having different maturity dates may reduce interest rate risk.
Default Risk: Bonds are subject to another type of risk – the risk that the bond issuer won’t have money to make principal and interest payments to bondholders.  Generally, investors who buy lower rated “junk” bonds are more at risk from default than investors who hold investment grade bonds.  Check an issuer’s credit rating with a bond-rating agency, such as Moody’s or Standard & Poor’s, to minimize default risk.
Inflation Risk: Over the years, the rising costs of goods and services can reduce the purchasing power of your savings.  If you invest the bulk of your money in fixed income investments, you may be at risk of not earning enough to reach your long-term goals.  Consider investing a portion of your money in investments, such as stocks, with the potential for earning higher returns to help reduce inflation risk.
Currency Risk: Adding international investments to your portfolio may provide diversification.* But be aware that currency exchange rates, foreign taxation issues, and differences in auditing and financial standards, among other things, can affect the value of foreign investments.
Play a role: You can’t prevent investment risk, but you can take steps to moderate it.  By diversifying your portfolio, you improve your chances that gains in one asset class may offset losses in another.  And, when you invest for the long term, you’ll have more time to recoup any losses.
*Diversification does not ensure a profit or protect against loss in a declining market.
**Content written by Newkirk, as distributed to Symmetry Partners, LLC.
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