by Stacy Francis, CFP®, CDFA
With the stock market behaving like a roller coaster carnival ride more people are looking for the riskless way to invest. A prospective client came in today to see if I had any ideas for risk-free investments and it got me thinking. I very much wish I did – and so I told her. The truth is, unfortunately, that there are almost as many types of financial risks as there are investments. Between inflation risk, market risk, company specific risk, industry risk, country specific risks (the most commonly referred to is political risk), and a myriad of others, it is not hard to see why many people choose to stay out of the markets altogether. And sure, not all financial risks can be avoided. But by following these three easy steps, you can lower your exposure and get more out of your investments.
1. Determine your spot on the risk-return curve. One of the most fundamental investment truths is that the higher the return you seek, the higher the risk you need to take on. Many bonds from well-established companies offer such small yields, you barely stay ahead of inflation. On the other hand, the chances that you’ll lose your money are minimal. If you, on the other hand, buy bonds in new, or otherwise more risky companies, you can get yields in excess of 20% per year -- but the company may go belly up and never pay you at all. Determine how much risk you are willing to take on, and invest accordingly.
2. Diversify. While turbulence exists on all markets and -- to some extent -- in all types of securities, it is unlikely that all companies in all industries in every country in the world will crumble at the same time. By spreading your capital between a number of markets, types of securities, and industries, you dilute your risk.
3. The best insurance against financial risk always is and always has been knowledge. You can stay up to date with the markets – or make your life easy and hire someone else to do this for you. A financially savvy advisor can smell a fraud, analyze balance sheets and income statements for you, and keep track of happenings in the industries on which you like to bet your money.
So while unfortunately there is no such thing as a risk-free investment, by determining your comfy spot on the risk-return curve, diversifying, and adding a pinch of knowledge to your investments, you can reduce and dilute your risk significantly.