Risk is a double-edged sword: Investors must take risks to make money and, in general, the greater the risk, the greater the potential for both profit and loss.
Both millionaires and non-millionaires cite the “level of risk associated with investments” as the top factor they consider when making financial decisions, according to Spectrem Group research. At the same time, these affluent investors credit “taking risks” as a key factor in building their wealth. Taking risk was identified as a successful wealth building strategy by 72 percent of investors with a net worth of $5 million to $25 million, excluding their home.
Maintaining a comfortable balance between risk and reward is a constant challenge for investors. The appropriate balance can shift over an investors’ lifetime and with the changing economic landscape.
Most Americans became more conservative during the Recession. The more unstable the real estate and stock markets seemed, the more investors increased holdings in safe investments such as cash and certificates of deposit, or turned to alternative investments, such as gold, which is seen as a safe haven in times of economic uncertainty.
As the economy slowly began to recover, investors started taking more risks and ventured back into the stock market. Affluent investors surveyed by Spectrem Group in December said they were becoming less conservative. More than half – 54 percent – of investors with a net worth or $100,000 to $1 million, excluding their home, described themselves as moderate, compared with 45 percent in 2009. The percentage calling themselves conservative fell to 28 percent in 2010, compared to 41 percent in 2010.
Investors typically behave more aggressively when they are young and just beginning to build wealth, while investors nearing retirement tend to be more conservative, and take more steps to preserve rather than grow their wealth.
Investors can learn to manage risk so that it works to their advantage, according to the Financial Industry Regulatory Authority, which licenses brokers. A portfolio containing several different types of investments can protect against two financial threats - investment and inflation risk.
Investments held in conservative products, such as a federally insured savings accounts, are considered safe, but can’t compete with inflation. Over time, money held in savings tends to lose its purchasing power. Stocks do a better job of keeping pace with inflation, but investors can lose money when a stock declines in value. A mix of cash, stocks, bonds and alternative investments, such as Real Estate Investment Trusts, help investors weather market ups and downs.
“For many people, it’s best to manage risk by building a diversified portfolio that holds several different types of investments,” said FINRA.