Millionaires rank managing risk as the most important criteria underlying their investment strategies. What do you need to know about risk and reward?
Millionaires rank risk as the most important factor to consider when devising investment strategies, according to Millionaire Corner research. Diversification, one of the most commonly used investment strategies to mitigate risk, is the second-most important criteria.
(Learn more about affluent investors’ attitudes towards risk.)
Why is risk so important to Millionaire investors? How does risk factor into the investment strategies of Main Street investors? According to AXA Equitable, “Investment risk comes in many forms, and each can affect how you pursue your financial goals. The key to dealing with investment risk is learning how to manage it.”
(Main Street investors appear unlikely to assume a high level of investment risk in the current economic environment, according to our research.)
Why do investors take risks in the first place? No risk, no reward, explains the Financial Industry Regulatory Authority, which notes that every investment poses some type of risk. “Just because you take investment risk doesn’t mean you can’t exert some control over what happens to the money you invest,” states educational materials provided by FINRA. “In fact, the opposite is true.”
The first step toward managing risk is becoming familiar with the types of risk associated with various investment strategies. According to FINRA, the two general categories of risk affecting investors are investment risk (losing money) and inflation risk (losing buying power). Investment risk and inflation risk are affected by larger economic and global events, such as the current credit crisis in Europe or widespread drought across the United States, but levels of risk also vary with individual investments.
Investors whose investment strategies include stocks, for example, can suffer losses due to extreme market volatility or to the failure of an individual company. Savings accounts guaranteed by the Federal Deposit Insurance Corp. will not lose face value, but they can lose purchasing power when low interest rates, the result of federal monetary policy, fail to keep pace with inflation.
What are the best investment strategies for managing risk? Most investors, say FINRA, can best manage risk through diversification.
“The process of diversification, spreading your money among several different investments and investment classes, is used specifically to help manage market risk in a portfolio,” according to AXA Equitable. Investment strategies for increasing diversification include purchasing pooled investments, such as mutual funds and ETFs, and adding alternative investments to a portfolio.