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Safety of
principal. Will you be able to at least get out of an investment what you put
into it? If you are in a position to risk your principal, you have the ability
to take advantage of investments with potentially high returns, like volatile
stocks or high-yield corporate bonds. If you are a few years away from
retirement and you need that money to live on, you may want to choose
investments in which your principal is safe. Some investments, such as fixed
annuities, guarantee your principal. Others, such as U.S. Treasury bonds, are
backed by such formidable credit that your principal might as well be
guaranteed.
Reliability of income. If you need regular income to live
on, repay loans or reinvest, you will want to choose securities that provide
reliable income, such as investment-grade bonds or blue chip stocks. Reliable
income, however, usually comes at the expense of large returns and growth
potential.
Preservation of purchasing power. Traditionally, we
describe risk in the terms discussed above. However, there is also another issue
to consider. You may have more dollars in the future than you have today, but
can those dollars purchase the same quantity and quality of goods and services
as today? We are talking about the impact of inflation; and when considering a
long time horizon, the effect can be as devastating as a market crash. Does the
after-tax rate of return of your investment exceed the rate of inflation? You
may have to trade safety of principal to preserve purchasing power. A good
investment strategy is risk-averse. In other words, it seeks to get the
greatest return with the least risk possible. You have to determine your own
risk tolerance—how much risk you can afford to take on as you seek to get
the best return. |
