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| Home > Education and Planning > Investor Education |
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| Investment CONCEPTS |
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Risk, Risk Tolerance and Return
How much risk can you stand in your investments? Is the thought of your investments going up and down keeping you awake at night? Or do you have "nerves of steel" and take market fluctuations with a grain of salt?
In simple terms, risk refers to the chance that your investment won’t grow as much as anticipated or the original value could decline. Risk tolerance is your ability to accept these risks. When choosing investments, be careful to consider your risk tolerance and determine a level of risk you can live with. Even the best-laid financial strategy can be hurt by losing your nerve in a market downturn. For example, if you invest in an equity mutual fund, most likely your investment will go up and down on a daily and monthly basis. If this bothers you, then another type of investment, such as a less-volatile bond fund or money market fund, may be more suited to you.
Simply put, some people are more uncomfortable with risk than others. And the thought of the value of their investment going lower frightens them. But people who make riskier investments may benefit from higher returns over the long term. Conversely, those who make less risky investments may accept a lower rate of return on their investments as a trade-off for greater peace of mind. Return is the amount of profit, either earnings, dividends or appreciation, you make on your investment.
Understanding Risk
When thinking about risk, keep in mind that there is no such thing as a "risk-free" investment. When you make an informed decision to assume some risk, you also create the opportunity for reward. This is a fundamental principle of investing known as the risk/reward tradeoff.
Risk covers the whole spectrum of investments and includes:
- Market Risk – The possibility that share values will fluctuate in response to market conditions.
- Credit Risk – The possibility that a bond issuer may not be able to pay interest and repay its debt.
- Inflation Risk – The risk that a portion of an investment’s return may be eliminated by inflation.
- Interest Rate Risk – The possibility that a bond’s or bond mutual fund’s value will decrease due to rising interest rates.
- Currency Risk – The possibility that share values will fluctuate in response to changes in currency exchange rates.
- Liquidity Risk – The possibility of limited volume and frequency of trades for certain issues.
One strategy that may help you reduce many types of investment risk is diversification. By investing in a variety of investments among different asset classes, you can reduce the impact on your portfolio if any one investment experiences a significant decline.
Your Investment Time Horizon
The time you have from when you invest to the point when you need to use the money you’ve saved is called your investment time horizon. A general guideline is that the longer your investment time horizon, the more risk you may want to take.
If you have at least 15 years until you’ll need the money, you might consider making higher-risk investments -- for the chance of getting a greater return. Mutual funds with only stocks in the portfolio are examples of higher-risk investments. If your investment time horizon is between five and 15 years, you may want to lower the amount of risk. A mutual fund compiled of stocks and bonds may be more appropriate in this case. And if you have a short time horizon, four years or less, you’ll probably want to make ever lower-risk investments, such as investing in a money market fund or government securities fund. With this little time, it would be difficult to rebuild your investment portfolio if there was a large downturn in the world’s economy and markets.
Further diversifying your portfolio among a mix of assets may provide another barrier against sharp declines in one type of investment.
Diversification
You’ve probably heard the saying, "don’t put all of your eggs in one basket," time and time again. In the investment arena, following this advice can be crucial. What this adage means is that you can reduce or spread your risk by placing your money in more than one type of mutual fund or investment.
This process, called diversification, is the ability to potentially offset the drop in the value of one investment with a gain in another. For example, if you’ve placed all of your money in stock mutual funds and the market goes down, your savings could be hit hard if you need to make a withdrawal. If, however, you have diversified your portfolio to include bonds and stable investments, the impact of the decline in the value of your stocks may have been minimized. Please remember, diversification does not assure a profit nor protect against loss.
Mutual funds are diversified themselves. A mutual fund may be made of as little as 20 stocks to over a hundred. If one stock drops or does poorly, the others can "make up for it" and may offset the drop.
Selecting your investments
Once you’ve pinpointed your investment time horizon and have a good feel for your risk tolerance, it’s time to learn more about your investment options. The following descriptions briefly explain the types of investment available:
Stable Investments
These investments are designed with safety in mind – to preserve the money you’ve put into the investment and little or no fluctuations of value. Some examples of stable investments include money market funds, certificates of deposit (CDs) and government securities. These investments are typically low-risk and, as a trade-off, provide a lower return. Even if you have a long time horizon, you may want to consider stable investments as part of the diversification strategy of your portfolio. They provide a safe harbor during periods of uncertainty over other markets or can be simply used as an emergency fund.
Bonds
If you are an investor with a medium tolerance for risk and an intermediate or long investment time horizon, you may want to consider using bonds as part of your overall investment strategy. In the simplest of terms, bonds are IOUs issued by governments and corporations and are considered a moderate-risk investment because of their price fluctuations. Each bond has a market value, which fluctuates with changes in interest rates. It also has a maturity date of when the bond will be paid and usually generates the same amount of income each year until it matures.
Generally, the longer the time until the bond matures, the greater the chances that its value may go up or down. However, a longer maturity usually means a better rate of return. A bond fund is a pool of bonds, each with a different maturity, which can include government bonds, corporate bonds and other debt instruments.
Stocks (equities)
Stocks, or equities as they are often called, represent ownership in a corporation. Their returns are achieved by an increase in the value of a company and by dividends paid to shareholders. Stocks are considered higher-risk investments than bonds or stable investments and are typically selected by investors with long-term time horizons. Historically, stocks offer some of the highest long-term returns of any investment. Most stocks display volatility, meaning the value fluctuates with company, industry and stock market changes, so the amount you earn may change on a daily basis. There are many kinds of stock funds with different goals and degrees of risk.
Balanced Funds
A balanced fund is a portfolio containing stocks and bonds. Although the percentage of stocks and bonds in the fund determines the amount of risk, most balanced funds are managed to achieve moderate risk. Since a balanced fund invests in both stocks and bonds, diversification is built in. However, depending on your investment time horizon and risk tolerance, you should consider further diversifying your portfolio with stable investments or stock funds.
Investors should consider a fund's investment objectives, risks, charges and expenses carefully before investing. For this and other information about The 787 Fund and AXA Enterprise Funds, download a prospectus, ask your financial advisor for a copy, or call 1-800-432-4320. Please read a prospectus carefully before you invest or send money.
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