When it comes to investing, there are two areas that we scrutinize incessantly – risk and return.
What is investment risk? Consider the definition of risk: “a situation involving exposure to danger.” The definition helps us to craft the right question. The question becomes, “what is the exposure to danger” in your/with your investments? It’s the exact question every investor needs to be with! What is the associated risk with any investment of yours!? Can you measure it? Can you identify or quantify it?
The answer for each Tencap client is yes! The answer for our investment methodology is yes!
Then, go one step deeper…. Can you identify the heuristics in how you are seeing your preferred investment? Can you identify the emotion or “hope” around how you see that investment? In other words, can you yield to the facts and data, surrounding investment risk, or is the “story” you are telling yourself, or being told, too loud?
Understanding the risk profiles associated with different types of investments is crucial for managing the wealth of high-net-worth and high-income individuals and families. Whether you’re investing in stocks, bonds, real-estate, specific sectors of the markets, private equity or cash equivalents; each comes with its own risks and potential rewards.
This article will guide you through the different investment types, focusing on identifying the associated risk.
What is Investing Risk Tolerance?
Investment risk tolerance refers to the degree of willingness and acceptance of uncertainty and market volatility as an investor.
Understanding your risk tolerance is a crucial aspect of investment decision-making. It determines how much risk you can accept in pursuit of potential returns. Some investors adopt a conservative approach, preferring low-risk investments with stable but small returns. Others have a higher tolerance, opting for high-risk investments with the prospect of high returns.
Identifying your risk tolerance forms the foundation of your investment strategy, shaping your portfolio’s composition and potential growth trajectory. By carefully assessing your financial goals, time horizon, and comfort with risk, you can align your investments with your unique circumstances and objectives.
What Are the Different Types of Investments and their Risk Levels?
There’s a wide range of investment types to consider, each carrying different levels of risk and potential returns. Here’s a brief look at some of the most common ones.
Buying shares of a company’s stock means you own a piece of the business. Stocks have the potential for high returns, but they also come with a high level of risk because their values can fluctuate dramatically.
Bonds are essentially loans you give to a company or a government. In return, you receive interest over a specified period and the return of the principal when the bond matures. They are considered safer than stocks, although they generally provide lower returns.
Mutual funds are money pooled from several investors to place in a portfolio of stocks, bonds, or other assets. They provide diversification that can lower risk, but their returns depend on the performance of the investments within the fund.
Investing in real estate involves buying property for rental income or capital appreciation. While it can provide steady cash flow and potential tax benefits, it also involves risks, like illiquidity and property depreciation.
Commodities include physical assets like gold, oil, or agricultural products. Their prices can be volatile, influenced by supply, demand, geopolitical events, and other factors.
Cash equivalents are the safest types of investments and include things like money market funds or Treasury bills. They offer low returns but carry the least risk of losing principal.
Remember, the key to successful investing is a well-balanced portfolio that aligns with your risk tolerance and financial goals.
Which Investment Type Typically Carries the Least Risk?
Cash equivalents: the conservative
Cash and cash equivalents, such as money market funds and Treasury bills, are often considered safe havens in the world of investments.
The key characteristic that distinguishes them from other investment types is their very low volatility. This is mainly due to their short-term nature, with most cash equivalents maturing in less than three months.
The trade-off for this safety, however, is low returns. Cash equivalents offer a lower yield than more volatile investment types like stocks or commodities—but come with greater security—because they are not subject to the same market fluctuations and are generally backed by government or financial institutions,
Although not the most glamorous or exciting investments, cash equivalents can provide a foundation for a balanced portfolio. They offer stability and principal protection, appealing to conservative investors or those nearing retirement.
While these investments carry the least risk for capital loss, they might not outpace the inflation that could erode your purchasing power over time and can be a significant risk to your financial plan.
Bonds: the middle ground
When we move a step up the risk ladder, we encounter bonds.
Bonds are loans by investors to entities such as governments or corporations. These entities promise to repay the borrowed amount with interest after a set period. Compared to stocks and more volatile assets, bonds are generally considered a lower-risk investment option.
There are different types of bonds with varying degrees of risk.
Government Bonds issued by the federal government are seen as the safest as they are backed by the full faith and credit of the government. Municipal Bonds are issued by city or state governments and are also relatively secure, albeit slightly riskier than government bonds.
Lastly, Corporate Bonds are issued by companies and carry a higher risk as their ability to repay depends on the financial health of the issuing corporation. While they offer higher potential returns, they also have a higher risk of default.
The key to investing in bonds is understanding the trade-off between risk and potential returns. While bonds are less risky than stocks, they can carry more risk and potentially higher returns than cash equivalents.
Diversification: Spreading the Risk
Diversification, in essence, is a risk management strategy that blends a wide variety of investments within a portfolio.
The idea behind this technique is rooted in the age-old saying, “Don’t put all your eggs in one basket.” By investing in stocks, bonds, and cash equivalents, investors can potentially mitigate risk and smooth out the bumps on the financial road.
Remember, the goal isn’t to eliminate risk but to maximize your return for whatever level of risk you are comfortable taking.
Financial Advisors and Risk Management
Professional financial advisors, like those at Tencap Wealth, can be instrumental in guiding you toward the most suitable investments based on your circumstances and financial goals.
With their comprehensive understanding of the financial landscape and expertise in risk management, these advisors can utilize any investment tool out there. Tencap is an independent firm that answers to no one, except for regulators and our clients. Any tool, investment type or fund that is available, can be used by the Tencap team.
So what investment types does Tencap use in their portfolios? Maybe more importantly, why do they use what they use? Of all the questions any potential clients can ask us, in our purview, this is one of the most important questions to be clear on.
Know that we can’t wait to answer this for you. Know that we have spent hundreds of hours creating, reviewing and tweaking our investment methodology. Know that behind that question is an entire world of investing and academics that are ultimately answering two questions…. How do I reduce/minimize risk, and elevate return? That’s the antithesis of the question, is the nucleus of investing.
If your advisor does not have Nobel Prize-Winning luminaries backing their investment philosophy, it may be time to interview another group.
Tencap Wealth Coaching is here to help
If you’re interested in working with a financial planning professional to help build the right investment plan, then Tencap Wealth Coaching is here to help.
At Tencap Wealth Coaching, we’re focused on helping you achieve all your financial goals and more through academically sound financial planning. From investment management to retirement planning and tax strategies, we are here to manage the complexities of your money and allow you to relax and enjoy life. Learn more or schedule an introductory meeting below.
Nick trains and develops families in creating, maintaining, and growing wealth. This includes educating clients on the science and academics of investing, comprehensive financial planning, and ongoing coaching to ensure discipline for a lifetime. Nick has seen this create incredible levels of freedom, fulfillment, and love for the families he works with.