Risk vs. Reward

When you invest in a mutual fund, there is no guarantee that you will end up with more money when you withdraw your investment than what you invested to begin with—and that’s a scary prospect. Loss of value in your investment is what is considered risk in investing. Even so, the opportunity for investment growth that is possible through investments in mutual funds far exceeds that concern for most investors.

At the cornerstone of investing is the basic principal that the greater the risk you take, the greater the potential reward.

Risk then, refers to the volatility -- the up and down activity in the markets and individual issues that occurs constantly over time. This volatility can be caused by a number of factors -- interest rate changes, inflation or general economic conditions. Different types of mutual funds have different levels of volatility or potential price change, and those with the greater chance of losing value are also the funds that can produce the greater returns for you over time. Mutual funds offer incredible flexibility in managing investment risk. Diversification and automatic investing are two key techniques you can use to reduce your investment risk considerably -- and help reach your long-term financial goals.

Diversification as a Risk-Management Tool

Diversification reduces some investment risk by making sure all of your eggs are not in one basket. Mutual funds, by nature, are diversified investments since they invest in a pool of many different securities. You can further diversify your mutual fund investments by investing in different types of mutual funds. The theory is that when one investment style if “out of favor,” others are likely to be performing better. In this way, diversification can help even out the ups and downs that market swings can cause in your overall portfolio.

Time Horizon & Risk Tolerance

If you have a considerable amount of time to invest, you can afford to take more risk with your investments because you’ll have time to outride the market’s ups and downs. As you draw nearer to needing your money, it is wise to review your portfolio and considering allocating your assets more conservatively.

Inflation Risk

What does inflation have to do with the amount of investment risk you’re willing to assume? You need to consider the risk that being too conservative in your investment style could have over the long term if your investments don’t outpace, or at least keep up with, inflation. Therefore, you may want to consider taking on a little more risk to avoid the risk of inflation.

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