By David J. Blount, CFP®
Investing can be an important aspect of building wealth and securing your financial future, but it comes with a variety of risks that individuals should be aware of prior to making any investment.
In this article, we will explore different investment risks and provide valuable insights into managing these risks, as well as discuss essential financial considerations that can help you make informed decisions for your financial well-being.
Investment Risks
Stock Investing Risks
Stock investing either through buying individual stock or stock mutual fund means that you own a piece of a company or companies. Investing in stocks involves the risk of fluctuating prices, political risks, business risks of the decision making in individual companies and the potential loss of principal. The prices of small and mid-sized stocks and international stocks tend to be more volatile than those of domestic large-company stocks, making them subject to higher market swings. In general, the younger you are the more risk you can consider taking with your retirement savings.
Bond Risks
Bond investing either through individual bonds or bonds mutual funds means that you become a creditor or banker to a company, municipality, or government. You essentially are exchanging your savings for interest payments and they promise to pay you back at a fixed date in the future. Bonds are subject to risks as well such as reinvestment risk, call risk, default risk, and interest rate risk. When interest rates rise, bond values tend to decline and when interest rates decline bond values tend to appreciate. The availability and prices of bonds can also fluctuate, affecting their market value.
Real Estate Investment Trusts (REITs)
Investing in REITs is a sector-based stock investment in real estate investments that carries specific risks to this industry. These risks include management risk, liquidity risk, interest rate risk, supply and demand and share value transparency. It's important to note that REITs may not be suitable for all investors, and there is no guarantee that the investment objectives will be achieved.
Commodities and Precious Metals
Commodities, including precious metals, can experience fast price swings leading to significant volatility in an investor's holdings. They also come with increased risks such as political, economic, and currency instability. They can be highly volatile influenced by factors such as weather, geopolitical events, and market sentiment about future commodity prices. The use of leverage in commodity futures prices can amplify gains but also magnify losses. The prices of gold, silver and platinum can be very volatile like other risky assets demonstrating large price swings. Investing in physical metals can require large upfront investments and be subject to theft or natural disaster. While these investments can offer diversification, they should be approached with caution due to their inherent risks and used as a diversifier and not a core holding.
Source: Investing in Commodities | Meaning, Methods, Pros, & Cons by True Tamplin
Mutual Fund Risks
Investing in mutual funds involves various risks depending on the type of mutual fund. If it is a stock mutual fund, then it will share similar risks as stocks above and if a bond mutual fund, then the risks associated with bonds as described above. Sector funds such as real estate or commodities share similar risks as those investments. Although the main difference is the benefits of diversification you get through a mutual fund. Instead of owning one stock or bond for your investment you can own dozens, hundreds, or thousands of stocks or bonds in one investment. This diversification among many can potentially eliminate the permanent loss risk of owning a single investment. Fund values fluctuate with market conditions, and they may not achieve their investment objectives. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Money Market and Stable Value Funds
Money market and stable value funds are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. While they seek to preserve the value of your investment, it is possible to lose money when investing in these conservative investments. Additional risks include interest rate risk, liquidity risk, credit risk, inflation risk, and investment expenses.
International Investing:
Investing in international markets carries unique risks, including currency fluctuations, higher transactions costs, liquidity risks, interest rate risks, transparency risks, and political instability. These risks can be heightened when investing in emerging markets. While these investments can offer diversification, they should be approached with caution due to their inherent risks and be used as a diversifier and not as a large core holding.
Target Date Funds
Target Date Funds are a type of mutual fund investment that spreads your money across different types of investments based on your age and the year you plan to retire or need the money. Target date funds start off with more risk when you're young and have a longer time horizon before you need the money. As you get older, the fund becomes more conservative by reducing stocks and increasing bonds and cash. Target date funds gradually shift their emphasis from more aggressive investments to more conservative ones based on the target date or year. Current target dates extend out to 2060 and the investor basically matches the year they anticipate retiring with the year of the mutual fund and the investment company manages it accordingly. These mutual funds will carry the risks of the underlying investments such as bonds and other investments. However, it's important to know that not all target date funds are the same. Different companies may have different allocations to stocks and other investments for the same target retirement year. For example, one company's 2020 Target Date may have 45% stocks while another company's fund may have 60% stocks. Consequently. The risk of target date funds for the same year can vary in the amount of risk imbedded in the fund. This can make a big difference in the size of the losses during a market decline.
Target Risk Funds
Are a type of mutual fund investment that allows investors to allocate their savings based on a specific level of risk that they feel comfortable with and is often discerned after completing a risk tolerance questionnaire or analysis. Once the allocation is set, it remains relatively constant, with occasional adjustments to keep it balanced. The fund manager is responsible for making sure that the level of risk stays within the target range. Target risk funds are usually labeled as "conservative," "moderate conservative," "balanced," "growth," or "aggressive growth" to indicate the level of risk involved. Conservative funds have less stocks and lower risk, while aggressive growth funds have more stocks and higher risk. Target risk funds allow investors to adjust their risk in response to personal life changes. These mutual funds will carry the risks of the underlying investments such as bonds and other investments.
Miscellaneous Financial Considerations
Employee Stock Purchase Program
Some advisors will suggest owning no more than 5-10% of your employer's stock as a rule of thumb. Diversifying your investments can help preserve your retirement savings in case your company's fortunes take a turn for the worse. Many people have had their retirement savings decimated or even wiped out by owning too much of their employer’s stock. Some people may remember the Enron or Global Crossing scandals from the early 2000’s where employees invested everything in the company stock only to have the said company go bankrupt and those employees constantly lose all of their retirement savings.
Disability Insurance
Consider purchasing Long-Term Disability Benefits to protect yourself from unexpected health challenges. Disability insurance can be less expensive through your employer and provides essential coverage, particularly for professions where minor health issues can impact your ability to work. A good group disability insurance policy can replace up to 60% of your income in the event you suffer a long-term sickness, injury, or disability.
Life Insurance
Group life insurance benefits provided by your employer may not be sufficient for your family's needs. It's recommended to evaluate your life insurance coverage, with the rule of thumb being 10-20 times your annual salary in total coverage. A personal life insurance policy can provide the flexibility you need for your specific requirements and provide peace of mind knowing that you won’t lose your life insurance if you change jobs, suffer a disability or get laid off.
Emergency Fund
Generally, this is an amount of money that is three to six months of income needed to fund your monthly living expenses during a period of sickness or unemployment or for repairs such as an auto repair or air conditioner. The idea is to keep this money in a safe, liquid, and non-risky investment such as a savings or checking account. This is important to help preserve your long-term investment success as the emergency fund will provide a store of cash to use when financial challenges arise thus keeping you from robbing your retirement savings.
Longevity Risk
Longevity risk basically refers to the event of running out of money before you run out of life. The key is doing an adequate job of protecting your retirement income needs and investing in a way to fund those over a long period of time. Managing longevity risk involves careful planning and may include strategies such as purchasing annuities, reassessing retirement age, and maintaining a balanced investment portfolio.
Final Word
Remember, all investments carry some level of risk, and there is no one-size-fits-all approach to investing. Understanding the various risks associated with investments is essential for making informed financial decisions. You can navigate the complexities of the financial world and work towards securing your financial future with the following key steps.
Carefully consider your risk tolerance and implement a portfolio suitable for you.
Diversifying your portfolio across many of the investments listed above.
Creating a plan for managing retirement income and investments before and after retirement.
Seeking advice from a qualified financial professional such as CERTIFIED FINANCIAL PLANNER™.
About Us
David is President and CEO of Investment & Insurance Planning Services, LLC (IIPS), an independent and fee-based firm that helps clients establish their financial goals and creates custom financial plans to help them pursue those goals. They specialize in working with pre-retirees, individuals in a career transition, L3 Harris engineers, and JetBlue pilots. David’s motivation comes from seeing his clients pursue their goals. He says, “It’s very rewarding to help people make successful transitions from one career to another, start a small business, or retire.”
David received his bachelor’s degree from Troy University, and prior to becoming a financial planner in 2000, he had a nine-year career in the United States Coast Guard. He obtained the CERTIFIED FINANCIAL PLANNER™ designation in 2007. He has served as the guest financial expert on Orange Television’s Adult Lifestyle Magazine Show and frequently provides financial and retirement planning workshops. Outside of work, he enjoys spending time with his wife, Michelle, their two kids, Ryan and Alana, their dog, Jack, and visiting with friends. An avid outdoorsman, he enjoys fishing, hiking, exercise, and as a committed person of faith, he enjoys attending church and is passionate about helping people in his community. To learn more about David, connect with him on LinkedIn.
Parts of this article were enhanced with the help of artificial intelligence.
The opinions voiced in this article are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.
This material contains only general descriptions and is not a solicitation to sell any insurance product or security, nor is it intended as any financial or tax advice. For information about specific insurance needs or situations, contact your insurance agent/advisor.