How to be Successful in Investing from Kiplinger — Part III

The next key for you to be successful in investing is to have a good judgment between the return you expect and the risk you are willing to take in order to reach your investment goals.

In the third segment of the Kiplinger's "The Five Keys to Investing Success" series, the author made the argument of "Don't Take Unnecessary Risks" in investing. If there are risks are deemed as unnecessary, there must also be some risks that nobody can avoid. So what are they and how these will risks affect your investments? To begin with, let's take a look at the definition of risk involved in investing. According to Investopedia, risk is

The chance that an investment's actual return will be different than expected. This includes the possibility of losing some or all of the original investment. It is usually measured by calculating the standard deviation of the historical returns or average returns of a specific investment.

In other words, risk is the chance that when you invest $100, you may only get $95 back when the investment ends. Since most investment instruments do not guarantee the return of principles (ever noticed the "Not FDIC Insured" phrase?), by using these instruments in your investment, you also inherit the risks associated with each of them. However, even for safety-heaven type of investments such as CDs (remember those FDIC signs at banks?) and Treasury notes/bills which guarantee the return of principles plus interests if you hold them to maturity, you can still "lose" money if the inflation rate outruns the interest rate.

For the two most common investment vehicles, stocks and bonds, the article gives some simple examples of risks involved. For stocks, the risk is that the stock price could decline if "the company’s revenue declines or isn’t being managed well." Bonds, on the other hand, risks of losing value if interest rates fall as bond prices "move in the direction opposite to that of interest rates."

If nothing is considered safe, does it mean an investor should give up high-risk investments and invest only on low-risk assets? The answer depends on the investor's risk tolerance level and investment time horizon as historical data showed that stocks always outperformed bonds in the long-term. The key is to find the balance between risks and returns and feel comfortable with a certain type of investment vehicle and its associated risk, as the article concluded:

What is a prudent risk? It depends on your goals, your age, your income and other resources, and your current and future financial obligations. A young single person who expects his or her pay to rise steadily over the years and who has few family responsibilities can afford to take more chances than, say, a couple approaching retirement age. The young person has time to recover from market reversals; the older couple may not.

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