Risk. Probably a word that is thought of almost immediately after someone starts discussing investing in the stock market. “That sounds risky.”
It can be.
But do you know what I believe to be far more risky?
Choosing to hold all your cash in a savings account earning close to nothing. The value of your dollar today would continually diminish year over year leaving you with less and less buying power and potentially an inability for you to live the lifestyle you want in the future. Good old inflation.
There is some form of risk associated with each and every type of investment or asset class. Whether you choose to invest in what is perceived to be “safe” or you choose to invest into the stock market, there are inherent risks with each of these financial decisions.
Below is a breakdown of some of the risks connected to our financial choices.
Diversification is the process of investing across multiple different asset classes (cash, bonds, stocks, real estate, etc.) with the ultimate goal of reducing your exposure to risk.
Everyone assumes that the risk with investing only relates to the notion that your money could lose value as a result of investing in the stock market. But what people don’t often think about, is the risk that comes into play with each and every financial decision you choose to make.
Let me explain….
If you were to place all of your money into cash – the belief is that you would have little to no risk at all. However, as noted above, one could argue that this decision would be a significant risk in the fact that you are holding all your assets in one asset class that is diminishing in value over time due to inflation.
If you were to place all of your assets into equities – you would be exposing yourself to much greater risk. As now your investments may lose value as a result of the volatility in the stock market.
Diversification allows for you to participate in the rewards of being an investor but meanwhile managing the risk and downside you are exposing yourself to. It’s a balance of risk and reward through your selection of investments.
Each investment type will respond in different ways and in varying degrees of intensity to the market. Some investments are directly correlated in that when one goes up the other does as well. And some are indirectly correlated in that when one is seeing momentum, the other will be lagging.
Having a diversified portfolio that invests across multiple asset classes, multiple companies in varying industries and market size will be paramount in your desire to reduce or manage your risk.
So before you choose to invest in one thing vs. another, it’s important to have a general understanding of the risks associated with it. What other opportunities are you foregoing as it relates to this investment decision. What other factors about your lifestyle or needs should you be considering. How much risk am I willing to take.
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