All investment involves some amount of risk, but that doesn’t mean you should take on an unnecessary level. Managing risk is an important aspect of investing. To manage your risk, you need to understand the riskiness of different investments, how much risk you are willing to take on, and how you can invest in such a way that reflects your risk preferences.
Learn more about investment risk below, and contact Good Life Financial Advisors of West Virginia for assistance with your investment strategy today.
Risk & Reward
One of the first things to understand about investment risk is its correlation to reward. Generally speaking, the amount of risk you take is directly proportional to your level of potential return. A high-risk investment can potentially generate large returns, but it can also suffer larger losses. A more conservative investment typically has less upside, but may also have less downside than riskier investments. Having your money in a savings account is less risky than investing it in the stock market. But responsibly investing in the stock market gives your money the opportunity to grow, over time, in a way that a savings account does not.
There are many factors to consider when evaluating risk. Markets fluctuations can affect the risk level of many investments. Circumstances in your life may change, creating a need for higher returns. We will work together to manage and monitor these factors, taking the appropriate steps to keep your risk levels in line with your investment goals.
Volatility
You know that some investments are riskier than others, but how can you figure out how risky an investment is? There is no perfect answer, but one useful tool is volatility. Volatility is a quantifiable metric that can be used to help measure risk by calculating how much a stock goes up and down.
A stock that loses ten percent of its value in one month and then gains twenty percent the next month is a stock with higher volatility than one that steadily increases each month. The volatility of a stock is calculated using standard deviation. A higher standard deviation equals higher volatility, which means higher risk. When considering risk, it’s important to remember that any calculations are being calculated using historical returns. Though this can be a useful benchmark, it is no guarantee of the future.
Risk Profile & Time Horizon
Just as risk is not necessarily a bad thing, a certain level of risk is not necessarily good or bad either. Instead, the amount of risk that is appropriate is based largely on the specific situation and temperament of the individual. This is known as a risk profile. Your risk profile is how much risk you are willing and able to stand.
There are a few factors that affect your risk profile. One of the largest is the length of time until you’ll need your invested funds, which is known as your time horizon. If you’re in your thirties and investing money for retirement, volatility doesn’t affect you much, as long as the overall trend is positive. In contrast, if you’re saving for retirement and are only a couple of years away from retiring, a more volatile investment with more ups and downs could be too much risky for your situation.
Markets
Stock prices move every second of every day the market is open. Interest rates fluctuate in the same fashion. As these levels move up and down, so does the risk associated with these investments. A stock that was once “cheap” may now seem “expensive” and have more downside risk. Bond values can be negatively impacted in a rising interest rate environment. News headlines can suddenly jolt the markets, both positively and negatively.
There’s no perfect science to navigating the markets, but multiple factors must be taken into consideration to keep your investments in line with your risk tolerance.
How Much Risk is Appropriate for You?
Taking on an unnecessary amount of investment risk can have a negative effect on your financial future. Determining the amount of risk that you can handle and implementing strategies to mitigate your risk requires educating yourself and staying aware. For more information and guidance on understanding and managing investment, speak with a financial advisor from Good Life Financial Advisors of West Virginia.