Is there truly a “risk free” investment? To consider this question it is first necessary to define and understand risk. Only after you understand the different risks of investing and the tradeoffs necessary to minimize that risk can the appropriate portfolio be constructed to pursue your financial goals.
Most people equate risk to losing money. Many companies and business enterprises fail. This is called business or capital risk. In addition to investigation into the business and its financials, the best way to minimize capital risk is through diversification, where owning a number of well managed businesses spreads the risk of failure to an acceptable level.
Volatility in valuation is closely related to the marketability of the investment. Owning a residential or commercial property may be a good investment, but you will never really know what the value of your investment is until you sell it and the check clears. Publicly traded companies have their ownership units traded on a stock exchange where buyers and sellers exchange ownership in a few seconds for a known value. This marketability means that the balance of buyers and sellers will determine that moment’s valuation. We enjoy the marketability when there are more buyers than sellers, but there are times when the sellers overwhelm the buyers and the value will decline. This is volatility or market risk. While the daily value of a publicly traded company will be subject to this balance of buyers and sellers, a business that is able to grow its profits through sound management stands a good probability of growing its value over time, and if this company pays its shareholders a share of that profit (known as dividends) it is quite possible that the dividends will grow over time as well.
You might also consider loaning your money to banks, governments or companies to receive an interest (income) payment. You will typically receive a fixed interest payment for the use of your money for a specified term and (hopefully) repayment of your investment after the term expires. Sounds good until you realize that the fixed income payment, which might be taxable, offers you less purchasing power as inflation erodes both the income and the maturity (repayment) value of your original investment. This is known as inflation risk and, for many people, represents the most significant risk to their lifestyle, especially in their retirement years. Other considerations of risk with these loans (bonds) involve credit risk (ability to stay in business) and interest rate risk (as your loans are valued in a market in relation to changes in interest rates).
In summary, there is no such thing as a “risk free” investment. To minimize or eliminate one type of risk, you must accept another risk. Understanding the type of risk necessary to potentially achieve your long term financial goals is the result of a solid financial plan.
Azimuth Wealth Advisory of Raymond James has been providing guidance to individuals and families for over 30 years. Let us know if we can assist you and your family in planning your financial futures.
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Dividends are not guaranteed and may fluctuate, and a company’s future ability to pay dividends may be limited. There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices rise. Past performance is not indicative of future results. There is no assurance these trends will continue or that forecasts mentioned will occur. Investing always involves risk and you may incur a profit or loss. No investment strategy can guarantee success.