Making Investment Choices: Risk & Return

Risk and return are part of the same equation when you are investing.

  • When you invest in a stock, bond or mutual fund, you are taking a risk that the stock or bond will decline in value.
  • In other words, you have no guarantee that you will end up with more money than you started with.

 

How are Risk and Return Related?

  • Stocks are higher risk than bonds and have historically had a higher return.
  • Bonds are higher risk than cash investments(certificates of deposit and money market funds) and therefore have had a higher rate of return than cash investments.
  • The long (or longer) shot has a higher pay-off than the sure thing.

 

What is Inflation Risk? 

Because the cost of living increases each year (some years a little, some years a lot), you need to get some return on your investments equal to or above the inflation rate, or your savings and investments will lose ground.

  • For example, if you keep your money in a savings account or a certificate of deposit that is earning 6% and the inflation rate is 4%, your real return is only 2%.
  • If it is earning less than the inflation rate, you are really losing money.
  • You may have reasons to do this in the short run, but in the long run, it is not a good idea.

 

Why is it Important to Diversify?

  • By investing in a number of different stocks, bonds and cash investments, you can decrease the risk. Mutual funds are one good way to start spreading your risk, or diversifying.
  • Although it is important to have some of your money in cash, bonds and stocks (see WISER Fact Sheet: Don’t Put all of Your Eggs in One Basket), you still have to decide how much you want to put into each, and what funds, stocks and/or bonds you will invest in.
  • The advantage of no-load mutual funds is that you don’t have to pay any commissions or sales fees. This makes it less expensive to invest in more than one, big name mutual fund.


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