If you want investment reward, you will have to assume some risk. Anyone investing in securities - particularly stocks - must accept that reality.
Investing in the markets gives you an opportunity to accelerate the growth of your savings and outpace inflation, and you definitely want that chance, but how do you cope with the risks linked to it?
Here are the four varieties of investing risk and tactics that may help you manage or counteract them.
Diversification and concentration risk: This occurs when a portfolio isn't varied enough. Some investors have everything in a handful of stocks or a couple of funds representing just one or two "hot" market sectors. If macroeconomic factors hurt those companies or industries, that undiversified portfolio may suffer a major setback. Even a bad earnings season may do significant damage.
Tactic: Diversify across asset classes, moving money into investments that provide broader market exposure. Avoid a glut of holdings in a given sector, even a sector everyone insists is "hot." The flavor of the month can sour next month. Broad diversification gives investors a chance to capture gains in different market climates and sets them up for less pain if a particular sector or asset class dives.
Reinvestment and timing risk: All investors would like to buy low and sell high, but some succumb to impatience and leap in and out of the market. In attempting to time the market, they end up hurting the long-range performance of their portfolios. The weakness of buying high and selling low has caused too many investors to miss the best market days. Besides that, bond investors commonly face reinvestment risk, the hazard that a bond's coupon will end up reinvested someday in a lower-yielding security.
With regard to stocks, here are some long-term statistics worth noting. Standard & Poor's research shows if a hypothetical investor had simply parked $10,000 in an investment mimicking the S&P 500 on January 1, 1994, and just watched it for 20 years, he or she would have wound up with $58,350 at the end of 2013. If the same investor was out of the market for just five of the top-performing days during those 20 years, he or she would have amassed only $38,723.
Credit quality, interest rate and inflation risk: As you invest in the bond market, these three risks must be watched. A corporate bond's rating (credit quality) may be downgraded by S&P or Moody's, for example, implying a greater default risk for the bond issuer and signaling less certainly that you'll redeem all coupons and principal. Interest rates can climb, sending bond prices south. Rising inflation can turn a bond that seemed like a "can't lose" investment years ago into a loser at the date of maturity.
General market risk: Anyone with a foot in the markets must recognize systemic risk - the potential that many or all market sectors may be riled by shocks such as a geopolitical crisis, an act of terrorism, a recession or a natural disaster. How do you cope with that?
Tactic: In the bigger picture, you could look into a core-and-satellite approach to investing: passively managed investments at the core of a portfolio, actively managed investments as the "satellites" seeking greater returns in different market climates under the guidance of a skilled money manager.
Rebecca Schoonover may be reached
Comparisons to major indices are for illustration purposes only. It is not possible to invest directly in an index. All examples are hypothetical and are for illustrative purposes. Past performance is not a guarantee of future results.
Securities and insurance products are offered by Cetera Investment Services LLC, a registered broker-dealer and registered investment adviser, member FINRA/SIPC. Cetera Investment Services is not affiliated with the financial institution where investment services are offered. Investment products are * Not FDIC/NCUSIF insured *May lose value *Not bank guaranteed *Not a deposit * Not insured by any federal government agency. This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.