Risk is unavoidable if you want to invest in financial markets. Maybe you want to maximize risk for the biggest potential payoff or maybe you want to minimize risk to play it safe and protect your assets. Either way, you need to understand the inherent risk in any investment class and weigh it against your age, goals, and resources. Once you understand the risk factor for any potential investment, only then can you make a smart decision about what works best for you.
The major investment asset classes include savings accounts, savings bonds, equities, debt, derivatives, real estate, and hard assets. Each has a different risk/reward profile.
Here's a look at those asset classes and what they represent in terms of risk.
- Understanding risk, including the risks involved in investing in the major asset classes, is important research for any investor.
- Generally, CDs, savings accounts, cash, U.S. Savings Bonds and U.S. Treasury bills are the safest options, but they also offer the least in terms of profits.
- Corporate, municipal, state and federal bonds have different levels of risk that investors need to consider, but are overall far riskier than savings bonds.
- Equities, including equity mutual funds, or exchange-traded funds (ETFs) that track equity indexes, are risky as well.
- Futures and options are both complicated and risky but also offer unique opportunities for big returns-a risk/reward scenario investors need to weigh.
- Commodities are risky, however, a mutual fund or ETF that is commodity-focused might offset some of the risks.
CDs and Other Safe Havens
The safest investments are savings accounts and certificates of deposit (CD), which are protected by Federal Deposit Insurance Corporation (FDIC) provisions. These investments are the safest asset class available.
Cash, U.S. Savings Bonds, and U.S. Treasury bills are almost equivalent. Each has a similar risk, and the interest rate offered by each is nil or negligible. For accounts that are bigger than what FDIC provisions allow for, however, they are the next closest thing to being guaranteed.
Marketable Debt and Equities Are Risky
Marketable debt is risky. Even though these instruments are bonds, they are quite different from their savings bond cousins. Corporate, municipal, state and federal bonds carry varying levels of risk. Rating agencies such as Standard & Poor's and Moody's publish detailed reports and offer ratings on companies' ability to service debt issues.
Equities and equity-based investments such as mutual funds, index funds and exchange-traded funds (ETFs) are risky, with prices that fluctuate on the open market each day. Taking regular losses in a managed and disciplined way is essential to any stock trading plan. Successful risk management is the key to any stock investment method or system.
Understanding the risks of each asset class is crucial in portfolio planning; but those risks can still vary per individual investor when questions of age, goals and investable income are considered.
Derivatives Are Risky and Complicated
Derivatives are risky and may be difficult to understand, which presents a risk in itself. Futures and options are moderately complex, and investors in each are capable of incurring substantial losses. However, derivatives also offer unique opportunities to profit, which astute investors have earned great amounts of capital utilizing. Constant research and application of a sound plan are essential for managing the risk involved with trading derivatives.
To temper the risk of buying commodities outright, an investor might consider a commodity-focused mutual fund or ETF.
Gold, Silver, and All That Glitters
Commodities such as gold and silver may be owned through futures. Some gold investors own gold coins as a hedge against political instability or the devaluation of a currency. While such efforts may be based on good planning, the value of gold bullion during periods of political instability has varied widely throughout history. Commodities are risky.