Why it’s essential to understand risk: In order to plan for your financial future, you need to understand that investment risk and returns are intertwined, you can’t have one without the other. In general, taking on more risk can potentially provide both greater rewards and greater losses. It’s important to note too that investment risks go beyond the normal ups and downs related to market volatility.
Some risks of low-risk investments: Low-risk doesn’t mean risk-free. Here are two examples of the risks associated with low-risk investments. The first is inflation; if your returns don’t keep up with it, the future purchasing power of your savings can be significantly reduced even if you don’t make any withdrawals. The second is the risk of longevity, the possibility that you could outlive your money if your investment growth doesn’t keep up with what you spend.
Some risks of high-risk investments: Here are two examples of the risks associated with them. One is market risk – the chance that you could lose some or all of your money if the market value drops substantially. Investments outside Canada may also be subject to currency risk. For example, if you invest $100 CDN in a U.S. dollar denominated investment and the U.S. dollar declines by 10 per cent against the Canadian dollar, your investment will be worth $90 even though the U.S. investment value may not have changed.
Risks with the wrong type of investment: An example of this is a 20 year old investing their RRSP contribution into a “safe” high interest savings account or a five year GIC paying 2% when they have 45 years or more of future growth potential.
Why it’s important to work with an advisor: Investment risk affects people differently, so it’s important to discuss your personal feelings about risk with your advisor. Together, you can build a portfolio designed to achieve your goals that are within your comfort zone. Following are three strategies that can help you to manage risk, while alleviating the effects of market fluctuations.
Dollar-cost averaging: Investing a small amount regularly lets you buy at different price points and average out the cost of your investments.
Diversification is investing in different asset types (for example, stocks and bonds), industries or countries to help reduce the impact of underperformance in any given category.
Keeping pace with life’s changes by meeting regularly with your advisor and adjusting your portfolio as you move into different stages of life can help keep your investments aligned to your time horizon and tolerance for risk.
Talk to your advisor if you have questions about fluctuations in the value of your investments. It’s important that you are comfortable with your portfolio, and that comfort comes when you have a better understanding of risk. Consider one of Warren Buffet’s favourite quotes: “Time in the market beats timing the market.” This is best illustrated by someone who invested just $100 in 1950 in the USA Small Cap Stock Index Fund and left it to grow, it would have a market value of close to half a million dollars today!
*This article courtesy of Manulife Financial’s Solutions Magazine
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