Balancing Risk & Reward

In exchange for return, all investments assume a certain level of risk. Risk is the possibility your investment will lose value. Indeed, some investments are more volatile than others, but no investment is risk-free.

Generally, investments offering the greatest return potential contain the highest degree of risk. For example, among the three major asset classes (stocks, bonds and cash equivalents), stocks historically have offered the highest returns. But, in exchange for those returns, stocks have experienced greater volatility than other types of investments. Conversely, bonds and cash equivalents have generated more modest returns and lower amounts of volatility. (see chart)

One of the best ways to temper portfolio volatility while maintaining attractive return potential is to diversify. And one of the best ways to achieve broad diversification may be to invest in mutual funds. By investing in dozens or even hundreds of securities, mutual funds may help reduce investment risk. And, when you invest in a handful of different mutual funds holding different types of securities, you further increase your level of diversification.

When selecting funds best-suited to your goals, you should consider your need for return versus your tolerance for risk. You also must consider your investment time horizon. Your time horizon is equivalent to the amount of time you have to achieve your goal. Typically speaking, the more time you have to reach your goal, the more risk you may be able to assume.

Remember this: The greatest risk you face as an investor may be investing too conservatively. Investing too conservatively could cause you to fall short of your goals. It could also mean losing your portfolio’s purchasing power to the effects of inflation.