June 28, 1996
Graying of America
In our ongoing commitment to continuing education, Howard attended a seminar given by the Chief Investment Strategist of Merrill Lynch and the Annual FINRA required Compliance Seminar given by Complete Financial Services. Most speakers talked about the baby boomers coming effect on the economy, that they will need increased health care and financial services. We are aiming to fulfill the second need and are committed to bringing you the best of the ideas out there.
Investment Risk-Knowing Your Limitations
The stock market, as measured by the S&P 500*, is delivering excellent returns again this year. Considering that the S&P 500 was up over 38% in 1995, this year`s performance (1996) is especially impressive. Not surprisingly, investors are pouring their savings into investments at unprecedented rates, and while these returns are enticing, it is important that investors understand the risks associated with their investments.
Setting the Stage--An evaluation of investment risk must consider the investor`s overall financial goals. Thus, the first step is to identify financial goals (i.e., what, how much, and when) and list them in order of importance. Once the reasons for investing are identified and prioritized, then it is time to think about the amount of investment risk the investor is comfortable assuming.
Types of Risk--Assessing risk involves knowing both the various types of investment risk and the investor`s tolerance to assuming these risks. The following are brief descriptions of the most common types of risk investors face.
Investment Risk Definition
Market Risk
The uncertainty due to changes in the general level of market prices for investments, caused by political, social, and/or economic changes.
Company Risk
The uncertainty that a particular company may fail to meet future earnings expectations, be unable to pay dividends or interest, or succumb to the competition.
Credit Risk
The risk that a company, agency, or municipality may experience difficulty in paying its debts.
Interest Rate Risk
The risk that interest rates may rise and decrease the value of an investment.
Inflationary Risk
The uncertainty that investments will not keep pace with inflation and purchasing power will be reduced.
Reinvestment Risk
The uncertainty that the investor will not be able to reinvest the earnings and/or principal at the same rate of return that the initial investment earned.
Industry Risk
The uncertainty that a particular industry`s performance may impact the growth of the investment.
Currency Risk
The uncertainty that currency fluctuations may affect the value of foreign investments or profits when converting them into the investor`s local currency.
Risk Tolerance-- Personal feelings about investing impact all investment decisions. Ultimately, an individual investor`s tolerance to risk will determine the boundaries for appropriate investments. There is no right or wrong personal risk tolerance, but investments should never cause you to loose sleep!
Risk Versus Return-- Most investors prefer certainty over uncertainty. As rates of return become more uncertain, investors expect higher returns. The tradeoff between risk and return is fundamental to all financial decisions, and consequently, to implementing an investment strategy.
Importance of Time--The length of time that investments will be held is the single most important factor in any financial plan. Historical performance is never a guarantee of future results; however, market history indicates: (1) volatility, or risk, of stocks decreases significantly over time; (2) the return on equity securities exceeds the return on fixed income investments over long periods; and (3) investments that are appropriate for long-term financial goals are inappropriate if the investment frame is relatively short.
Diversification and Asset Allocation-- The lack of diversification ("having all of your eggs in one basket") can be a risky proposition. Many investors diversify their investments; however, having all investments in one type of investment still exposes investors to the risks of that asset class.
Different categories of investments typically do not all perform well at the same time. For example, stocks and bonds often react differently to the same economic or political news. By spreading investments among various types of asset classes ("asset allocation"), a portfolio is better prepared to handle the inevitable ups and downs of the markets.
Your financial and investment advisor can provide you with more information on an appropriate investment risk and asset allocation strategy and should be consulted before any action is taken.
Howard Lisch is also a licensed stockbroker who can help you develop an investment strategy to potentially meet your needs.
If you have any questions about this or any other financial matters, please call me.
* indices are un-managed and can not be directly invested into.