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Risk and Return


Sure, you'd like to make a fortune in the markets -- who wouldn't? The first thing you need to understand, before you commit even a dollar to a portfolio or begin surfing investing Websites, is that it's impossible to realize a return on any investment without facing a certain degree of risk.

According to Webster's, risk is the "possibility of loss or injury." In investing, risk is the chance you take that the returns on a particular investment may vary. That's another way of saying that there are no sure things when you're investing.

No matter what you decide to do with your savings and investments, your money will always face some risk. You could stash your dollars under your mattress or in a cookie jar, but then you'd face the risk of losing it all if your house burned possibly less dollars in real terms than when you started. Investing in stocks, bonds, or mutual funds carries risks of varying degrees.

The second fact you need to face is that in order to receive an increased return from your investment portfolio, you need to accept an increased amount of risk. Keeping your money in a savings account reduces your risk, but it also reduces your potential reward.

While risk in your portfolio may be unavoidable, it is manageable. The riddle of controlling risk and return is that you need to maximize the returns and minimize the risk. When you do this, you ensure that you'll make enough on your investments, with an acceptable amount of risk.

So, what constitutes acceptable risk? It's different for every person. A good rule of thumb followed by many investors is that you shouldn't wake up in the middle of the night worrying about your portfolio. If your investments are causing you too much anxiety, it's time to reconsider how you're investing, and bail out of those securities that are giving you insomnia in favor of investments that are a little less painful. When you find your own comfort zone, you'll know your personal risk tolerance -- the amount of risk you are willing to tolerate in order to achieve your financial goals.

When it comes to your long-term financial future though, the biggest risk of all may simply be to do nothing. If you don't invest for retirement, or for the college education of your children, or to help meet your personal financial goals, then you're most likely guaranteed a future of just scraping by.