It is to someand it is certainly something that most people try to avoid. But in the investment world, risk is impossible to avoid. In fact, risk and long-term rewards are generally related.
Low-risk investmentshigh-quality bond funds and other fixed-income alternatives—produce more annual income and are more stable, but have no real growth potential.
High-risk investmentsdiversified stock holdingscan bounce around in value each year, but they offer the potential to grow in value in real, after-inflation terms over long time periods.
That’s why, for long-term investors, risk can actually be a good thing. Indeed, successful long-term investors understand that without the presence of risk, there is no potential for reward.
The trick is to get risk to work for you, and not against you.
Risk is tamed primarily by reducing it down to an acceptable level. Here are several important ways:
|The Many Faces of Risk|
In the investment world,
there are many different
kinds of risk. Here are
three of the biggest risks
facing 401(k) plan
Inflation Risk: Inflation nibbles away at the real value of fixed-income interest and principal payments. Long-term bond funds are particularly vulnerablethey are extremely volatile in terms of principal, and offer no growth over the long term. Money market funds barely keep pace with inflation, and therefore offer no real purchasing power growth.
Market Risk: Corrections and bear markets drag down the returns of even the strongest stocks. Stock portfolios are the most vulnerable over short time periods, when plunges as deep as 30% are possible.
Interest-Rate Risk: When interest rates rise, bond prices fall, lowering the value of existing bonds. Bond fund investors face this risk directly, and the longer the maturity of a bond or bond fund, the greater the risk.