Investing - Rish and Reward

You invest because you think that you can make money. However, you can lose money too. That's risk. For example, you could buy a share of stock for $10 and it could increase in value to $50 or decrease in value to $0.

Some stocks are riskier than others. Often the riskier an investment is, the greater it potential gain. A larger potential gain can also mean a larger potential loss. How much risk is appropriate? It depends on three factors:

Your age. The younger you are, the longer yo have to gain back money you lose because you'll be working and investing for many years.

Your financial situation. If you support a family or your saving for a specific short term goal then you will want to take less risk.

Your personality. Some people are adventurous while others are nervous when they feel their money is at risk.

Investing - Risk and Reward

Each method of investing and every unique investment comes with its own risk and potential benefits. When you select an investment, make sure that you understand what the risks are as well as what type of investment will work best for your financial situation. Here are several different ways to invest your money:

Savings Account
Certificate of Deposit
Money Market Account
U.S. Bond
Mutual Fund
Stock
Collectibles

Where should you invest your money? You also need to consider the following when investing:

Safety - How risky is the investment? Safety is a measure of risk. A safe investment is one with little risk of losing money. An investment that is not considered safe may have a high likelihood of lsoing some or all of the money that you invest.

Liquidity- How easily can you get your money out of the investment? Can you afford to leave your money in an investment for a long period of time?

Return on investment - How much might your investment earn? Investments with a low rate of return might not make much money. But they also may not cost much to begin with.

Losing at the investment options listed above, collectibles is a risky investment but it could potentially bring a great rate of return. A savings account has very low risk, but it may not bring your a large return.

In order to make higher returns, you may need to invest more, but that may also mean that you risk more. Investments with lower potential returns may earn less, but you're less likely to lose your money. You need to think of each investment as a trade off between risk and reward.

Investing - Risk Tolerance and Capacity

Before you invest, it's important to consider both your risk tolerance and your risk capacity. Risk tolerance is your willingness to take on risk. Risk capacity is how much risk you can afford to take on given your financial situation. Both are equally important.

Most people are risk-averse. That means, with everything else the same, they would prefer less to more risk. It also means that they would prefer the highest expected return available for a given level or risk. It makes sense then that any investor would take on additional risk because they expect to earn a higher rate of return on that investment.

Think of it like this...there is a range of investment options available to you. The low risk option has a low rate of return but almost no risk, like a savings account or a certificate of deposit. For your parents, it might be sercurities issued and guaranteed by the U.S. government like a Treasury bill, note or bond. If you select this option you can expect to earn a low rate of return but the investment is not risky. Or in other words, your actual rate of return will be very close to the return that you expect.

The high risk option has a high rate of expected return but carries potentially a lot of risk. To select this option, you would need to be both willing and able to take on the risk associated with the investment. Potentially, you would need to be both willing and able to lose your investment.

Read more about risk and return at FINRA's Investing Strategies web site.

Investing - Risk

Everyday, we all take risks without even thinking about it. When you invest your hard, earned money, you need to think about what you expect for your return and how much you are willing to risk to get that return.

You can stash your cash in your top dresser drawer. There's no risk involved. But, it won't grow other than when you add to it. That means it has a zero growth rate. The up side it that it's always at hand. You don't have to drive to the bank to get it or you don't have to wait until it matures to withdraw it.

You want more than a 0% growth rate? Then, decide how much you expect to make from your investments and look at the risks involved. You'll need to strike a balance between your expectations and the risks involved to achieve them. Your bank or credit account, certificate of deposits, money market funds are insured. Ask to make sure! They have a little more risk but a larger growth rate.

Over the long term, stocks often offer a better rate of return. There are more ups and downs.