In the investment world, risk means uncertainty, and refers to the possibility that you will lose your investment or that an investment will yield less than its anticipated return. That uncertainty about the outcome of an investment means that investment risk also refers to the way the price of an investment fluctuates or changes in value from time to time–its price volatility. The more the fluctuation–in frequency and in amount–the higher the volatility. Generally, the higher the volatility, the greater the uncertainty about the outcome of your investment, and the greater the potential risk involved.
There are three factors that are key to understanding risk: (1) the risk-return tradeoff, (2) the investment planning time horizon, and (3) the different types of risks that exist. You should have a solid understanding of each of these issues in order to select investments that maximize potential returns within your acceptable risk levels. Here is a brief discussion of each.
(1) Risk-return tradeoff
As risk increases, the potential for return increases. This is known as the risk-return tradeoff. Historically, investments with greater risk have tended to provide higher returns, though past results are no guarantee of future returns. The more aggressive you are as an investor, the more risk you take, and the greater chance you may have to earn a potentially higher return (assuming any return is earned at all). Conversely, the more conservative you are as an investor, the less risk you take, and the less potential you have to earn a high return (though you’re also less likely to lose your investment).
(2) Investment planning time horizon
The length of time you plan to stay invested in a particular vehicle is referred to as your investment planning time horizon. Generally speaking, the longer your time horizon, the more you may be able to afford to invest more aggressively, in higher-risk investments. This is because the longer you can remain invested, the more time you’ll have to ride out fluctuations in the hope of getting a greater reward in the future.
(3) Different types of risks that exist
Finally, many types of risk can affect an investment. Each investment is subject to all of the general risks associated with that type of investment. Risk also arises from factors and circumstances specific to a particular company, industry, or class of investments.
Note: All investing involves risk, including the potential loss of principal, and there is no assurance that any investment strategy will be successful.
IMPORTANT DISCLOSURES
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