General Investing  >  Find the Right Balance Between Risk and Reward

Find the Right Balance Between Risk and Reward

With any decision you make in life, you need to decide if potential rewards offset any risks.

Weighing risks and rewards is important for decision making. It’s true for buying a home or changing careers. It's also true for investing. Knowing some of the risk factors and how to manage them may help you make better investment choices.

Take Smart Risks

All investing involves risk. It’s a fact, but not all bad. Taking on risk can be scary, but it may also help you get the returns you need to reach your goals. Questions to ask yourself are: How much should I take and how much am I willing to take? Two considerations are time and tolerance.

How Much Time Do You Have?

The longer you have to invest, the more risk you can likely take because your investments have time to recover from market drops. Generally, the closer you are to your goals, the less risk you’ll want to take.

How Do You Feel About Risk?

Knowing how you feel about risk can help you choose investments that fit you. However, also consider:

  • Taking as little risk as possible may prevent you from reaching your goal.
  • Choosing riskier investments to compensate for a lack of saving could put your investments in a precarious position.

Find Your Risk Comfort Zone

To find your comfort level with risk, consider your reaction if the stock market declined and the value of your investments suddenly dropped by 20%? Would you:

  • Sell everything?
  • Move to a money market fund?
  • Wait and see if the market rebounds?
  • Buy more securities because their prices are lower?

How you answer can give you a good idea about your risk tolerance. It can also help you decide what kinds of investments to include in your portfolio and how much of each.

Learn your risk comfort level and review investments that fit with our interactive Investment Planner tool.

Understand Investing Risks

Not all investments carry the same risks. Below are some to consider, as well as potential ways to manage them in your investment portfolio.

Market Risk

Economic events can cause the value of your investments to drop. Market declines can be spurred by anything from political events to the weather—any occurrence that causes investors to be wary.

Ways to Manage Market Risk

  • Diversify. Include a mix of investment types that react in different ways when markets change. When one area of the market is not performing well, it may be offset by others that are.
  • Stick to your strategy. Don’t become discouraged during market lows or overly optimistic during the highs. A long-term outlook is a better approach. It reduces the temptation to buy or sell investments based on emotion or short-term market events.

Inflation

Another long-term risk may be that your investment returns won't keep pace with inflation. Over the past 30 years, inflation has averaged about 2.5% annually.1

Ways to Outpace Inflation

  • Increase risk. You may need to take on some investment risk to get returns that will help you reach your goals. Note that riskier investments can mean higher highs, but also lower lows.
  • Add inflation protection strategies. Consider inflation-hedging investments in your portfolio.

Interest Rate Risk

Changes in interest rates affect fixed income investments. Higher interest rates usually mean lower bond prices, and vice versa.

Ways to Manage Interest Rate Risk

  • Diversify fixed-income. Choose bonds that have varying maturities levels. Maturity is the length of time a bond issuer has to repay the principal amount of the bond.
  • Consider time horizon. Longer duration bonds usually have higher interest rate risk. Shorter duration bonds are usually less volatile when interest rates rise. If you have a longer time to invest, you can usually endure the higher risk.

Investors with longer time horizons may want to consider intermediate-term maturities—between three and 10 years—for a balance of risk and return.

Credit Risk

Investing in bonds comes with the possibility of a bond issuer failing to repay a loan. Manage this risk by deciding which quality of bonds is right for you and evaluate credit ratings. Bond credit ratings reflect an issuers financial strength and ability to make timely interest payments at maturity.

Ways to Manage Credit Risk

  • Choose higher credit quality to minimize risk. Investment-grade bonds have less risk of issuer default but also lower yield potential. They have credit-quality ratings of BBB or higher.
  • Consider high-yield for higher returns. While these bonds carry a higher risk of default, they have more yield potential. High-yield bonds have credit-quality ratings of BB or lower.

Explore More

1 Source: Bureau of Labor Statistics, 2018

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.

As with all investments, there are risks of fluctuating prices, uncertainty of dividends, rates of return and yields. Current and future holdings are subject to market risk and will fluctuate in value.

Diversification does not assure a profit nor does it protect against loss of principal.

Generally, as interest rates rise, the value of the securities held in the fund will decline. The opposite is true when interest rates decline.

Credit letter ratings indicate the credit worthiness of the underlying bonds in the portfolio and generally range from AAA (highest) to D (lowest).