Worried about risk in the asset markets? There are certain ways you can think about it to help alleviate your anxiety.
Various economic and financial variables have combined to make global market participants fearful of risk, including the financial crisis and the widespread volatility in equity markets.
However, as investment guru Scott Holsopple notes in U.S. News and World Report, risk is inherent to investment.
While there are many types of risk involved in investing, the one that is most striking for many investors is downside risk – the possibility that you could lose some or even all of the principal that you put into an investment.
Risk Equals Reward
However, risk often comes along with reward. Financial gurus have long recognized something called a risk premium, which is the benefit that an investor realizes by putting their funds into an asset with more risk. The premium acts as their incentive, more or less.
This risk premium is easy enough to pick out in the current asset markets, as the S&P 500 has surged roughly 13 percent during the first 11 months of 2012, according to corporate data that was gathered by financial research firm EPFR Global and reported by CNNMoney The Buzz.
While bonds are generally considered to have lower downside risk and therefore a more stable store of wealth, the robust demand for these debt-based instruments has pushed their yields to record lows – and even negative levels during the year.
Volatility, or fluctuations in the value of a particular asset, is important in the minds of many investors. Holsopple states that if you are investing for your retirement, volatility is a factor that requires significant consideration.
As a general rule of thumb, if risk increases, potential returns increase. The opposite is true, as shrinking risk means dwindling returns. If you are willing to incur greater risk, you may be rewarded in the form of more appreciation. If you want to opt for less-risky investments, your returns could suffer.
When determining how much risk you want to take on, one key consideration is your investment horizon, meaning when will you want your money back from your investments.
If you want don't need your principal back for decades, this situation means you have greater opportunity to add more aggressive assets to your portfolio. If you have a long period of time to invest, then you can always recover if you take a risk and lose some money.
However, a shorter timeline should probably coincide with a completely different mindset. If you need your principal back in a year, the stock market may not be for you. In this event, you may want to look into options with less downside risk.
While the following factors can be helpful when you want to establish a retirement plan, there is a lot more information out there you can use.