Reassessing Your Risk Tolerance
The potential return from any investment can generally be linked to the amount of risk the investor is willing to assume. Finding that balance between the return you desire and the risk you can handle has never been easy. What makes this problem even trickier is that your financial goals – and thus your risk tolerance – inevitably change throughout your life. Therefore, the investment that was right for your goals of yesterday may not be so appropriate today.
It is a good idea to review your investments periodically with risk tolerance in mind. If you heed the advice of your financial advisor, you probably already review your account statements on a regular basis to monitor performance and change any investments whose time has passed. Take some extra time when doing this to screen your investments for inappropriate levels of risk.
Most people identify risk management with safety of principal. This is true to an extent – a dollar locked in a safety deposit box for 10 years will most likely be worth a dollar when it is taken out
Of course, that dollar is not likely to have as much purchasing power in 10 years as it does today. In other words, locking your money away exposes it to inflation risk. What you gained in stability, you lost in buying power.
Like that dollar in the box, some investments are also exposed to inflation risk. There are many other types of risk as well, which apply to different securities. The following are some of the types of investment risk you should keep in mind.
- Market risk – the possibility that an investment may lose its value when traded in the financial markets.
- Credit risk – the possibility that the issuer of an investment (a corporate bond, for example) may not live up to its financial obligations and cause you to lose your invested capital or not receive expected interest payments.
- Interest rate risk – the risk that, if interest rates rise, the price (value) of an investor’s bond holdings and certain stocks will decline.
- Reinvestment risk – the possibility that interest rates will fall as a fixed-income investment matures and cause you to be unable to reinvest matured assets at an attractive rate of return.
- Liquidity risk – the risk that you will be unable to liquidate an asset (such as real estate, collectibles or thinly traded stocks) when you want and at the price you want.
While the variety of risks is substantial, you should not let risk management intimidate you. People participate in the financial markets because the rewards have often enough outweighed the risks. By carefully assessing all the risks an investment offers and periodically reviewing the holdings in your portfolio with your financial advisor in consideration with your risk tolerance, you should be able to find a level of risk that is appropriate for meeting your investment goals.
This material was prepared by Raymond James for use by the financial advisor noted above.
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