Risk and return

One of the fundamental characteristics of any investment is that risk and return go hand in hand. The higher the risk you are willing to take, the higher the potential return. There is no such thing as free lunch.

As the famous motorcyclist Evel Knievel once said “Risk is good. Not managing your risk is a dangerous leap”. When applied to buying stocks and building your investment portfolio to meet your financial goals make sure you keep this in mind. Although returns are uncertain, risks can be controlled. The biggest risk you can face is not diversifying your portfolio. If you prefer selecting individual stocks rather than investing in highly-­diversified index funds or mutual funds, make sure you have a good mix between large-­cap, medium­-cap, small­-cap, value, growth, domestic and international stocks. Since the asset allocation decision is a critical step in reaching your investment goal, unless you feel very confident in this area we recommend you discuss this matter with a Certified Financial Planner(CFP).

In order to increase an investment’s long­-term returns you need staying power. Staying power enables you to stay the course even when things get rough. By staying the course you will can help minimize the impact that short-­term stock price fluctuations and may be able to invest in riskier stocks for higher potential returns.

As J. Kenfield Morley once said, “In investing money, the amount of interest you want should depend on whether you want to eat well or sleep well”. When defining your portfolio strategy you must first asses your risk tolerance which will determine the asset allocation between stocks and bonds. If you are able to sleep at night during market fluctuations and stay the course then you may have selected an asset allocation that works for you.

A lot of the risk (but not all) of investing in common stocks can be eliminated by adopting a diversified portfolio and a long-­term strategy. One parameter that you can use to compare the relative level of risk of a given stock is its Beta which indicates how much the price of a stock fluctuates compared to a benchmark (the market). The higher the beta for a stock (the more it fluctuates compared to the market) the riskier it is considered to be.

Make sure your investment strategy and selection of investment vehicles is aligned with your overall investment objective.

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