Top 3 risks in your portfolio
By Gary Silverman, CFP®
This week, we are continuing our look at risk and how it affects both your investment portfolio and how you need to manage it. We’ve seen there are three truths about risk: Risk exists in some form in every investment. To get greater investment rewards you accept greater risk. The risks an investor faces vary depending on how long an investor has to achieve her or his investment goals.
Today I want to look at the types of investment risks that exist. There are a lot of potential risks out there in the investment world. At one time I came up with about 17 of them—and I was probably missing a few. If you’ve ever read the risk section of a mutual fund prospectus, you’d think you were reading one of those little folded up warning sheets that comes with a prescription drug. You know, the one that lists all the side effects that the pill has.
I whittled down the list a bit. Here are what I consider to be the biggest risks that could be in your investment portfolio:
Principal Risk: One form of risk that everyone understands is “principal risk.” This is the risk when you buy an investment (a stock, bond or piece of land) that suffers a permanent decline in value. For example, if XYZ Corporation goes bankrupt, its bondholders may only receive pennies on the dollar for their interest-bearing bonds and holders of the company’s stock could see their investment go to zero.
Purchasing Power (Inflation): A risk that many investors ignore is inflation or purchasing power risk. Even a mild inflation can damage your standard of living. For example, over 25 years (the length of retirement for many people) inflation will rob over half of the purchasing power of your savings if it continues at “only” 3 percent.
Volatility: Another risk investors face is “volatility.” That's the chance that on any given day, the financial markets might value your investment at a price greater or smaller than it did yesterday. With some investments, the highs are higher, the lows are lower, and the journey between the two is faster. Stock prices are more volatile than bonds. Small stocks are more volatile than large stocks. Foreign markets are more volatile than the U.S. market. Almost all investments are subject to the risk of volatility. Even rock-solid U.S. government bonds and notes fluctuate in value when interest rates move.
In fact, this last one, volatility, is the type of risk that we’ve been using up to now to generically talk about risk. It is often confused with Principal Risk, which is why people are a bit scared of it. If you examine the definitions more carefully, you’ll notice a key difference. Volatility is the fluctuation in the value of your investments Principal Risk involves the permanent loss of the value. The difference is that with volatility, in time, the value comes back up.
Now that you know the types of risks we can discuss how to manage them. Next time.
This article was published in the Wichita Falls Times Record News on February 26,, 2017.
Gary Silverman, CFP® is the founder of Personal Money Planning, LLC, a Wichita Falls retirement planning and investment management firm and author of Real World Investing.