A GUIDE TO INVESTMENT RISKS

Risk is defined as the chance an investment will decline in value. Generally speaking, it is usually less risky to be a loaned investor than it is to be an owned investor (See A Guide to Investment Basics). This is often the case because it is less risky to find a business or government entity that will lend money and repay the loan in full (loaned) than it is to invest in a business through shares of common stock (owned) that may or may not increase in value.


SAVER OR INVESTOR?

Are you a saver or an investor? To answer this question, consider the following scenario.

Your 401(k) account balance is $50,000, invested for growth. The stock market drops over a period of three months and your account shrinks 25 percent ($12,500) to $37,500. After researching your options, would you be more likely to:

• transfer all of your money in your 401(k) account to a safer, more conservative option, or
• leave your portfolio intact trusting that, over time, your growth fund investments would recover the short-term losses?
  

Determining Your Profile

Risk tolerance is a key factor in determining your investment strategy. If declines or potential declines in your investments would cause you to lose sleep at night, you may have a low risk tolerance, indicating that you are most likely a saver. If you can accept a high degree of risk for the chance to earn higher total returns over the long term, you may have a high risk tolerance, indicating more of an investor profile.

All investment options, including those in your 401(k) plan, pursue one of three basic objectives: income, growth and income, or growth. Income options are generally the most conservative investments, while growth options have the highest degree of investment risk. Growth and income options are riskier than income options but less risky than growth options.

Determining Your Strategy

If you are a saver, you may want to invest a large portion of your account in an income option, and divide the remaining portion among growth options or growth and income options. Investors may want to invest most of their funds in growth options and smaller portions in growth and income options and income options.

You may be uncomfortable with the possibility that your retirement account could shrink by 25 percent, which is a possibility if all your money is invested in growth options. On the other hand, investing only in income options may not produce the returns needed to reach your retirement goal. That’s why allocating your 401(k) retirement account savings among several differing types of investments is considered a practical approach by many people.


INHERENT RISKS

Income Risks

Risks inherent in income investments include:

• The borrower might experience some temporary trouble and have to delay making interest payments
• When current interest rates rise, the value of existing loaned investments declines
• Once repaid, loaned money is worth less due to inflation
• The borrower might go out of business, defaulting on interest payments and failing to repay the borrowed amount

Growth Risks

Risks inherent in growth investments include:

• A company may not grow as anticipated and the value of its stock might not grow as quickly or as high as expected
• A company’s industry may fall out of favor. The result may be an overall decline in industry stocks, which may include the company in which you’ve invested
• The overall economy may enter into a recession and the price of stocks may decline
• A company may experience operating difficulties, causing their stock to decline in value
• A company may go out of business, causing their stock to be worthless