Understanding Risk
As an investor, there are several different types of risk
you need to manage. As a senior your understanding of the
different types of risk that investments can carry, and what
risks the investments in your portfolio present, can mean
the difference between having enough money in the latter years
of retirement, or falling short at a time when there is no
opportunity to recover.
Your first priority should be to manage the risks that apply
to your overall financial security. In order to build a strong
foundation for a lifelong financial plan, it is important
to be sure you have the appropriate safety net in place.
Selecting investments without first securing the proper protections
can leave you extremely vulnerable to life's catastrophes
be it an extended illness, liability claim or even death.
Will you have adequate resources for a Medicare supplement?
Will you need long-term care insurance or self-insure? Do
you need life insurance protection to insure your spouse’s
economic security if you pass first? The types of protection
you need and how much is a highly individualized matter.
Once you have a handle on your primary financial risks, then
you will need to choose investments that represent the appropriate
level of investment risk to meet your objectives. Your investments
must not only provide enough current income to meet your needs,
but must provide enough growth to allow for the impact inflation
will have on your income needs, as well as additional needs
you may have as you grow older such as higher uninsured medical
costs; help you may need to manage at home, like a gardener,
housekeeper, or home health aide; and other, as yet, unforeseen
costs.
Investment risk is defined as "The chance
of loss on an investment due to many factors including, market
conditions, the economy, inflation, interest rates, default,
politics, foreign exchange, call provisions, etc.". Most
of us are quick to admit we don't want to lose our money,
but there are different types of risks and understanding those
risks, and how they impact your money, is key to selecting
the right investments and insurance products for your needs
and goals.
Safety can be viewed from two distinctive views. Do you
want safety of principal or safety of purchasing power?
All investments carry at least one type of risk. Here are
the primary risks an investment may carry:
1. Inflation Risk.
This is the risk that although your money has grown in value,
it hasn't grown enough to keep up with inflation. This means
that your money will not have the purchasing power it originally
had. Inflation typically runs between 3-6 percent a year,
so low return investments run a genuine risk of losing ground
after you pay taxes on your gains. Keep in mind that if inflation
only grows at 3 percent a year, your income needs will double
in 20 years.
2. Financial Risk.
This is the risk that the issuer of the investment may run
into financial difficulties and not live up to their promise
or expectations. For example, the company’s products
may not achieve sales goals, or the firm could run out of
money.
3. Market Risk.
This is the risk of price fluctuations in the securities market.
Stock and bond prices do fluctuate and market conditions,
or public sentiment, may not reflect the true value of the
company. Even excellent, stable stocks can be subject to
overall market risk.
4. Reinvestment Risk.
This is the risk that when it becomes time to reinvest, you
may not be able to get as high a return on your money. This
could mean that you have to reinvest at a lower rate of return,
or take on additional risk to achieve the same level of return
that you want.
5. Interest rate risk.
In general, when interest rates rise, the prices of existing
securities drop. This occurs to bonds because new bonds will
be issued at a higher rate and so the market value of older
bonds, at a lower coupon, drops so that yield will be similar.
Stocks can drop due to interest hikes because when interest
rates are higher, many investors will shift their money from
stocks to lower-risk fixed investments.
In summary, an understanding of the risks involved in investing
can help you better understand and select from the myriad
of investment options open to you. As a retired person, it
is critical to balance the need for safety of principal, with
the need for long-term growth. One of the best ways you can
provide for both is to be sure your portfolio includes different
types of investment products that are not all subject to the
same risks. A discussion with your advisor and a good solid
plan is your best defense.
For more information that can help you better invest for
your retirement years, subscribe to our free
monthly newsletter, SeniorFinances, by clicking here.
|
