Managing Investment Risk

Managing Investment Risk

How can we successfully manage investment risk? Consider applying the principles of risk management discussed in our article entitled “Four Ways to Manage Risk.” Avoiding Investment Risk We should completely avoid high severity risks that are likely to occur, such as the risk of losing all of our money through gambling or investing in penny stocks. If you feel compelled to gamble for entertainment purposes, just be sure to do so only with however much you would be willing to flush down the toilet. Don’t make it your retirement savings strategy. I am opposed to gambling even for entertainment, though, because it can be very addictive and destructive, and it goes completely against the principles of wise stewardship. Reducing Investment Risk We can reduce investment risk through diversification, which means that we do not put all of our eggs in one basket. Many people who think they are well-diversified really are not. For example, I have met several people who think they are very well-diversified because all of their investments are in U.S. large-cap growth stock mutual funds with a variety of fund families. Typically they are shocked when I point out that most of these funds are actually investing in the same 100 or so stocks, and that many of these stocks are very similar to each other in nature. Sure, they are more diversified than if they were investing all in one stock, but true diversification would include a much larger variety of characteristics, such as geographic areas, sizes of companies, growth stages of companies, types of products or services provided (i.e. financial services, health care, technology, consumer...
Pay Off Debt or Invest For the Future?

Pay Off Debt or Invest For the Future?

Often people ask me whether they should pay off all debts before saving for the future or save first in hopes of earning a higher return on investments than they are paying in interest on debts. This is an age-old debate, and I have heard convincing arguments from Financial Advisors on both sides. The “Pay Off Debt” Argument Some advisors recommend that we liquidate all of our savings and investments except a very small amount, even as low as $1,000, to immediately pay down as much debt as possible. Then they recommend that we use every discretionary penny from each paycheck to eliminate the remaining debts as quickly as possible. After we are completely debt-free, then we can start saving and investing for the future. I admire people who are disciplined enough to follow this extremely aggressive strategy, but it is risky because it does not leave an adequate safety cushion. A $1,000 savings account would not be enough to cover unemployment, major unexpected expenses, or serious extended illness. What would happen to my house if I could not make my mortgage payment for six months due to unemployment? Would the bank cut me any slack because I had been paying them extra for the past year in hopes of paying my mortgage off sooner? Not likely. We should always maintain at least three to six months of living expenses in liquid savings, even if we have debt. The “Invest it All” Argument On the other extreme, some people recommend borrowing as much as the banks will allow and investing it all because they declare we can make more...
Where Should We Put Our Money?

Where Should We Put Our Money?

Although the amount we save is likely to have a bigger impact on our well-being than how we invest our money, we still need to invest it wisely. Choosing among the myriad of savings and investment options available can be overwhelming. How can we know where is the best place to put our money? Here’s some perspective from an investment advisor. Everybody Wants to “Help” You Invest. Countless financial institutions are constantly clamoring for us to park a piece of our pie with them. Why? That is how they make money. Unless we bury our money in the backyard, someone is going to make money off of our money no matter where we park it, even if it merely sits in a bank account. This is not a problem as long as we receive the benefits we expect in return. In order to be sure that the financial institutions meet our objectives and not just their own, we must be clear about what we are trying to accomplish with each dollar we deposit. My motto for savings and investment advice is “safety before speed.” Would you buy a car that can go from zero to sixty miles per hour in less than three seconds if it were not also equipped with excellent brakes, seat belts, and air bags? The potential rate of acceleration is much less important than the ability to avoid or minimize the impact of a crash. Without the safety elements, you may never reach your destination, no matter how fast you can go. Money works the same way. Many people lose the opportunity to be financially...