Investing Balancing Act –
Risk vs. Reward
F I N A N C I A L FYI
With any decision, you need to figure out if potential
finding your comfort zone with it can help you build a
rewards offset any risks. Investing is no different—you
portfolio that’s designed to endure, even under volatile
should consider the potential of losing money with the
market conditions.
potential of earning returns. Understanding risk and
What’s the Risk?
Understanding risks and how they can
impact your money can help you make
better investment decisions. Two long-term
risks are market cycles and inflation.
Market Cycles – The stock market is like a pendulum
swinging between highs and lows. Natural corrections occur,
such as when earnings are overinflated. You will likely endure
market swings to get the return you want. It’s important not to
get too discouraged during market lows, or overly optimistic
during the highs. We believe the best approach is to maintain
a long-term outlook and use investment strategies that will
help you get rewarded for the amount of risk you take.
Your Comfort Zone
Inflation – Another long-term risk may be that your
investment return won’t keep pace with inflation. While
inflation has been relatively low over the past 30 years, it
may not always be. Even a low inflation rate can impact your
investments. You may need to take on some investment risk
to get returns that will help you reach your goals.
More aggressive investing can mean
higher highs, but it can also mean
lower lows.
Now Build with Variety
Before making investment decisions, it’s good to know your
comfort level with risk. A good barometer of your comfort is to
gauge your reaction to a market drop. Let’s take two different
investors reaction to illustrate comfort with risk.
When their accounts dropped 20% during a market
downturn, . . .
Jack’s Reaction
Jill’s Reaction
Sell everything
OR
Move to a money market fund
Wait and see if the market rebounds
OR
Buy more because prices are lower
Jack has a lower tolerance for risk
and may want to consider a more
conservative portfolio
Jill has a higher tolerance for risk
and may have the appropriate
allocation for her portfolio
Once you have a good understanding
of risk and your own comfort level with
it, you can decide on investments.
A well-balanced portfolio includes
investments that react differently to market conditions.
That way a gain in one area of the market could offset
a decline in another—which may reduce the overall risk
in your portfolio. Spreading your money among stock,
bond and money market funds can potentially lower
your overall risk and help you ride out ups and downs.
It also helps to know what role each kind of mutual
fund plays in your portfolio.
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Each type of fund serves a unique purpose and reacts differently to market
changes–this is why you should include a mixture.
Alternative Funds
Money Market Funds
seek to preserve your money, and
allow easy access to cash (such as
through check writing). They hold
securities such as U.S. Treasury bills
that mature in less than one year.
are sometimes used to complement
traditional investments with assets and
strategies that aim to manage volatility,
lessen impact of severe market swings
and improve diversification. They also
come with a variety of risks.
Stock Funds
let you participate
in the growth of
multiple companies
and the economy in
general. There are a
variety of stock funds
based on the kinds of
companies in which
they invest.
Bond Funds
can provide income
and stability. Bonds
are essentially loans
from you to issuers like
governments, agencies
or corporations. The
issuers agree to pay you
back, with interest over a
set period.
Or, choose one that’s already diversified.
A convenient product for a balanced portfolio is an asset
allocation fund. Sometimes called “fund-of-funds”, these
are ready-made portfolios that already include a healthy
mix of stock, bond and money market funds.
An asset allocation fund can expose your portfolio to
more types of securities by spreading your investments
across a number of funds.
Asset allocation funds can be time-based or risk-based.
A professional money manager takes care of portfolio
construction and actively managing and rebalances the
portfolio.
Know Your Funds
STOCK FUNDS
Vary by style, location and specialty.
Investment style indicates the kinds
of companies a fund invests in:
BOND FUNDS
Are defined by the organization in
which they help finance growth,
development and debt.
MONEY MARKET
FUNDS
Fall into two categories:
TAX-EXEMPT - Invest
primarily in securities
that a state or
GROWTH - fast-growing companies
municipality issues.
thought to have high growth potential.
Income from these
AGGRESSIVE GROWTH STATE
AND
LOCAL
funds are generally
companies that seek faster-thanGOVERNMENTS - municipoal bonds exempt from federal
average share price appreciation.
finance public projects such as roads
income tax. However,
VALUE - fundamentally strong
and bridges.
income may be subject
compaies whose stocks are considered
U.S. GOVERNMENT - treasury
undervalued.
to state and local taxes
bonds to help finance the national debt.
and the federal
INDEX - seek returns that track a
benchmark index such as the S&P
Alternative Minimum Tax.
500® Index.
BLEND - seek capital growth by
investing in a mix of dividend and
non-dividend paying stocks.
BALANCED - invests in a mix of
stocks, bonds and money market
securities. The percentage of each
depends on the fund’s objective.
Country indicates the location of
companies the fund invests in:
CORPORATIONS - corporate bonds
for short-term expenses or finance
long-term projects.
ALTERNATIVE/SPECIALTY
FUNDS
ALTERNATIVES
Assets outside of
traditional stocks, bonds
and money markets that
use advanced
techniques.
SPECIALTY
Industries include
utilities, natural
resources, technology,
health care or real
estate
TAXABLE - Invest in
short-term government
or corporate securities.
May offer higher yields
than tax-exempt money
market securities.
However, all the income
from the funds is
subject to taxes.
INTERNATIONAL - companies in
developed foreign markets, such as
Europe, Australia or Japan.
GLOBAL - U.S. companies, developed
foreign and sometimes emerging
markets.
EMERGING MARKET - invest in
companies in developing markets such
as Russia, South Korea or Mexico.
REGIONAL OR SINGLE-COUNTRY companies in a particular region or
country.
The Bottom Line
Your portfolio needs to balance the right
amount of risk and reward so you can
meet your financial goals. Understanding
risk, how you feel about it and how each
kind of fund fits into your portfolio can
help you make informed decisions.
This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment,
accounting, legal or tax advice.
International investing involves special risks, such as political instability and currency fluctuations. Investing in emerging markets may accentuate
these risks.
Generally, as interest rates rise, the value of the securities held in the fund will decline. The opposite is true when interest rates decline.
Diversification does not assure a profit nor does it protect against loss of principal.
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