Holdings, or the contents of an investment portfolio, face hazards from time to time known as investment risks. These risks can be both systematic and unsystematic, and they occur in almost every investment ever made. They even exist in the U.S. treasury!
Some examples of systematic risks include recession, inflation, and other hazards that influence a market. Examples of unsystematic risks include regulatory and default risks. Due to these risks being industry and company-specific, they can be mitigated by diversifying your holdings.
It is important to note that it has been shown, through research and observation, that the lower the risk posed by an investment, the lower the returns that will be received. Almost every investment ever made comes with risks of principle. Some investments are less prone to risk than others. However, the trade-off is less earned income returned.
When the risk involved with an investment is lower, your mind is more at ease because you will not suffer as much of a loss. However, you typically will not gain as much money as you would have with an investment that came with a higher risk. In this situation, your biggest risk is the rate of inflation. For instance, in 2009, according to the measurement made by the Consumer Price Index (CPI), the rate of inflation was 2.5%. Here, the return from an investment was less than 0.5%. The investment was low risk, and therefore the return was even less than the inflation rate. With costs constantly increasing, it is exceedingly difficult to suffer this blow.
Therefore, in order to earn much higher returns in comparison to the amount was invested, you must be ready to make higher-risk investments. Corporate bonds, municipal bonds, and short-term government bonds are some low-risk investments. The returns are consistent and have minimal risk. However, this does not mean these returns will be higher than more risky alternatives.
Speaking of bonds, these are the lowest risk options that a person can invest in. Debt security is where the person making the investment gives the money in the form of a loan to the person issuing the bond. The bond takes the form of the return of the interest income. There are many types of bonds that differ in terms of their risk profiles. Some have higher risks than others. Here are some examples:
- Government bonds:
These investments are considered the safest, as the country’s government guarantees you the interest and the principal.
- Corporate bonds:
These have more risk than government bonds. With these, the interest and the principal are guaranteed by the company issuing the bond, and the financial status of this company determines the rating.
- Municipal bonds:
The state or the city issues this bond. Large infrastructure or any other type of improvement is funded. These bonds are rare, but there are some cases of default on these bonds.
To diversify your portfolio, you may allocate money to both low and high-risk investments to earn higher returns. A mixture of stocks and bonds can be chosen with a medium level of investment risk. Your investments will decrease in value with moderate risk investments. There are still chances of higher long-term returns if you remain steadfast and adhere to your portfolio. More aggression is needed if higher returns are desired. If you invest in a fund that is managed professionally, it is much less risky than when you purchase and hold each individual stock. Taking the risk where it is likely that you will lose everything results in fabulous returns. These are called high yield investments.
Carefully consider the risks involved in an investment and decide if the potential return is worth it. As with any major financial decision, do your research. Once you have studied your options, make the decision that is right for your portfolio and goals!
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