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 Introduction All financial products carry some degree of risk. In some products, like stocks and mutual funds, the risks are obvious - specifically, you might have less money tomorrow than you do today because of fluctuations in the market. In others, like CDs and money markets, the risks are not so obvious.Diversification When you diversify your investments, you spread your risk among different asset classes, increasing your opportunities to maximize return. Depending on your goal, you might include a mix of stocks, bonds, and cash vehicles, whether you buy them individually or in mutual funds. You may also wish to diversify within these asset classes. For example, if you invest in stocks, you might purchase stocks of large companies, small companies, and international companies. Market Risk The risk that the price of a security will fall due to changing economic, political, or market conditions, or due to a company's individual situation. This means that investments in things like stocks, bonds, mutual funds and real estate may lose value from time to time. Generally speaking, if you do not have enough to time (i.e. 10 years or greater) to recover from the potential dips, you should consider allocating less of your portfolio to securities subject to market risk.Credit Risk Credit risk, also known as financial risk or default risk, is often associated with investments into bonds. A bond, generally speaking, is a debt instrument (like an IOU) that represents the issuer's contractual obligation to repay its loan. Credit Risk relates to the risk that someone who invests in bonds will lose principal due to the business failure of the issuer. Bonds issued by the federal government are said to have minimal credit risk. High-grade corporate bonds carry relatively more risk, while non-investment grade ("junk") bonds generally have the highest credit risk. However, many bonds will typically pay a "premium," or a higher rate of interest, over federal government bonds to reward the consumer for taking on additional risk.Currency (Exchange Rate) Risk As the world has become a smaller and smaller place, many people have become more comfortable with the idea of international investing. As a matter of fact, many "model portfolios" put together by leading experts often assume that a certain percentage of one's assets will be invested either in U.S. companies that do business overseas, or in companies based in foreign countries. While investing abroad can offer additional opportunities for growth, it can create additional risk because of, among other things, political, economic and market volatility. Most notable is currency, or exchange rate, risk. Simply stated, currency risk is one that exists because of the fluctuations in the value of the currency underlying a security.Inflation Risk Inflation Risk is the chance that the purchasing power of assets or income will be diminished as inflation erodes the value of a currency. This means that things you buy today will cost you more in the future. For example, a good or service that cost $100 in 1980 would cost approximately $234.64 in 2001. This represents an average annual inflation rate of approximately 4.2%. To combat its long-term effects, consider taking greater risks and investing in vehicles, like stocks and mutual funds, that have the potential to outpace inflation on a long-term basis.Interest Rate (Reinvestment) Risk This applies to investors who generally seek a stable income, typically from bonds or CDs. A considerable risk is the inability to reinvest your interest earnings, and your principal at maturity, at the same rate in a time when the prevailing rates are falling. For example, if you currently invest in CDs that pay 5% annually, there is a risk that, when the CD comes up for maturity, the maximum rate that you will be able to get will be less than 5%.Tax Risk While income taxes are one of the two things in life that you can never avoid, there is good reason to make sure you are doing your best to minimize the amount of money you pay to Uncle Sam. For instance, an employer-sponsored retirement plan like a 401(k) is a great way to save for retirement and reduce your current income taxes. However, the IRS is patient and will wait until you or your heirs begin taking money out of these plans to collect their tax dollars. In fact, passing on these assets to the next generation may have disastrous income tax consequences. Your Guardian Financial Representative, in coordination with your attorney or tax advisor, can examine your current financial circumstances and help you develop a sound financial strategy that considers all the tax implications of your financial decisions. | |
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