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Risk vs Reward... Page 2
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Tolerance for Risk
You have to be comfortable with the investments you own. By simply assessing your risk
tolerance, you'll be able to determine what type of investments match your future goals
and personality traits. Finding a group of investments that let you sleep at night is the
ultimate goal.
Before investing in any mutual fund, you should answer the following questions:
- Your investing temperament... are you a
conservative, moderate, or aggressive investor?
- What are your current goals? Buying a home?
Retiring Early?
- How many years of investing do you have before
retirement? Generally, the younger you are, the more risk you can take.
- Are you willing to forfeit a chance for bigger gains in favor of a more stable
investment? Is a conservative approach more appealing to you?
- Are you willing to make adjustments to your portfolio from time to time? Will you
monitor your investments?
- How long will your money stay invested?
- Do you have trouble sticking to a plan?
Diversification
You've heard it before, "Don't put all your eggs in one basket".
Diversification is a safe approach to reducing risk. By spreading your money among
different investments, you'll be able to sustain a major drop in one part of your
portfolio -- you'll smooth out some of the volatility.
Mutual funds let you achieve a level of diversification not found in individual stocks or
bonds. The losses from one asset in a mutual fund can be offset by the combined
performance of other securities in the same fund. And by owning funds with different
objectives or styles, you'll be able to participate in higher returns with less risk.
Proper diversification involves finding the right balance for your portfolio. Generally,
this means a combination of equity funds, fixed-income funds, cash, and possibly
individual stocks. How you allocate assets to each of these investments depends on a
number of factors -- such as your age or number of years until retirement.
Subtracting your age from 100 is a conservative way to determine what percentage of
your portfolio belongs in stocks. So if you're age 30, 70% of your holdings would consist
of stocks. The other 30% would be fixed-income.
Next, you divide your equity and fixed-income investments into different levels of risk.
Percentages are used again.
Example using your stock holdings:
- 10% High Risk. Aggressive growth funds, International funds, or
individual stocks.
- 70% Moderate Risk. Growth or Growth and Income funds.
- 20% Low risk. Balanced or Asset Allocation funds.
You apply similar percentages to the fixed-income
side of your portfolio.
Next: Types of Funds
Mutual Fund Calculators:
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• How do growth and income
funds compare?
• Which is better: a front
or back load?
• Which is better: load or
no load?
• How much do fees affect my
return? |
