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Investments

RISKS & REWARDS

This is a visual representation of the trade-offs of certain investment choices. The low-risk, low-return investments are at the base. As the investor moves up the pyramid, the trade-off is safety against the chance of a higher return. Be cautious, as there are many different types of risks.

Webster defines risk as "the possibility of suffering harm or loss." These could include having your home burn down; the risk of an automobile accident; risk of being sued by someone injured on your property; risk of illness, death or disability; risk of having to enter a nursing home; risk of having a lower standard of living at retirement, etc. Specifically for investments, there are other types of risk. For example, the risk that inflation will cause one's cost of living to go up faster than one's income. When making investment decisions, what are some of the types of risks one needs to consider?

A. Market Risk--stock prices could decline and reduce one's investment capital.

B. Interest Rate Risk--Future interest rates can decline and reduce the income received from CD's, savings accounts, bonds, etc.

C. Credit Risk--the issuer of a bond could default on the interest and/or the principal payment.

D. Concentration Risk--the risk that by "having all your eggs in one basket," a bad investment could deplete both capital and income. It is important to diversify one's investments.

E. Risk of Doing Nothing--without a plan of saving and investing to fight inflation, many people will not have sufficient funds to provide for children's educations and for a comfortable retirement. It is impossible to eliminate all types of risks from an investment pyramid. Your individual "risk tolerance" -- your "risk/reward temperament" -- your concerns and feelings about inflation, safety, etc., should be determined. Risks can then be managed in a way that will help you be more comfortable with the degree of risk you decide to assume.

As a general rule, the higher up the pyramid, the greater the potential rewards and the higher investment or market risks. Conversely, the lower you go on the investment pyramid, the lower the rewards, yet the market and credit risks are also lower. The greatest risk of all is the risk of doing nothing!