What does wealth risk mean to you? How about investment risk? In personal finance circles, risk is more often associated with stock investments.
If you have savings, do you enter risk avoidance land and leave the savings in a CD or bank savings account, or are you measured in your assessment, know you are very risk averse and feel most comfortable with FDIC-insured accounts? Today’s installment, which takes Chapter 5 to its conclusion, covers a lot of ground, beginning with why it is impossible to “beat the market” when investing in risky assets like stocks to an ironic end that offers a quick process to evaluate individual stocks for inclusion in your portfolio. In between, valuable information for newcomers to mutual and exchange-traded funds gives every investor the best path to settle some of their savings in higher-return alternatives to bank products.
The most important lesson in today’s installment is wealth diversification.
Most households have sources of wealth beyond savings and retirement assets. A home, Social Security retirement benefits, and human capital are subject to risks different from those in a stock portfolio, bond portfolio, or other financial asset portfolio. When the stock market goes down, and you have a job, overall wealth declines less. When the stock market goes up, and you have a job, wealth increases, but the presence of a job narrows the rate of change. A retiree on Social Security retirement benefits has a floor of inflation-protected income, and the risk Congress changes the law differs from the risk in the stock market. When considering investing in your 401(k) or Roth IRA, the stock market waters are warmer than you think.
In the coming weeks, installments will show you how to self-assess risk tolerance, which can be matched with investment companies' prefab asset allocation offerings. What might that mean for future wealth? Readers will be amazed at how future living standards can be forecasted by learning a process commonly used by financial advisors.
Today: Investments have been the feature of Chapter 5, from the importance of setting up a brokerage account to the performance history of different asset classes and a discussion of inflation-indexed bonds. We conclude with how to manage investment risk through mutual and exchange-traded funds and begin with an excerpt illustrating that investment risk may not be what it seems.
Excerpt:
In the reading we learned about diversifying investments to not only achieve the best results but also to protect yourself from risks involved with top heavy investments. As stated in the reading, the traditional investment strategy has grown from a recommendation of 30 stocks to a number over 300. This is achievable with proper diversification especially utilizing mutual funds that already spread their risks appropriately. As discussed today in class, we can also look at other longterm investment options such as a roth IRA and a 401(k). Combining all of these forms of investment should result in a safer retirement plan.
My key takeaway is that diversifying your assets is extremely important for mitigating risks and maximizing returns, because it spreads investments across various categories, reducing our vulnerability to fluctuations. Therefore we do not want to put all eggs in one basket, rather multiple baskets.