Investor Education | Risk vs. reward: a delicate balancing act
The concepts of risk and reward are often paired in the minds of investors. Frequently, the higher the potential risk you are willing to take, the greater the potential reward can be. Conversely, a low-risk investment may yield a lower return than other comparable investments.
However, the exact nature of the relationship between the dual concepts of risk and reward is often misunderstood or oversimplified by the general public. This can result in decisions that could have an adverse effect on your portfolio in the long run.
For starters, be aware that human nature can play a prominent role in the equation. For example, you might stubbornly cling to a stock investment that continues to decline because you are unwilling to admit you made a mistake. In the meantime, you could be missing out on a more profitable opportunity had you invested the money elsewhere.
On the other hand, investors may be willing to take extraordinary risks for a chance at “hitting the jackpot,” even if the odds are much greater for a smaller payoff. This can be attributed to wishful thinking or inaccurate calculations — or both.
Classic example: Given the choice between a 1% chance to win $1 million and a 2% chance to win $500,000, some people, if not most, will risk their money on the $1 million bonanza. Of course, the odds for getting the $500,000 payoff are twice as high.
As a general rule, the best investment approach is to take a long-term perspective that focuses on your main financial objectives, while taking into account your personal risk tolerance. Undoubtedly, this is likely to include some exposure to risk in the equities markets. Frequently, investors will find that having a modest amount of risk in their portfolio is an acceptable way to increase the potential of achieving their investment goals. By diversifying their portfolio through investments with different degrees of risk, they may be able to take advantage of a rising market and benefit from some protection against losses in a declining market.
Of course, there is an inherent risk in this process, and there is not any absolute guarantee of future results, regardless of past performance (just like in life). You should consider all the critical aspects of assembling a diversified portfolio, including your financial status, your time horizon, your health and your personal risk tolerance.
Everyone’s situation is different. By developing a long-term plan for investing your money, you can strike a reasonable balance between risk and reward that is appropriate for your particular situation. It is recommended that you obtain assistance from investment advisers to develop an overall plan.
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Learn More | Contact Our Investment Specialists
Investment Consultant
Tam Hubert, CFP®, CFA
Investment Assistant
Kristi Remus
