How to understand risk and asset allocation.
When it comes to investing for your retirement, one of the great ironies is that avoiding risk is, well, risky behavior! Here are key considerations for how to approach risk, and some insights into why it has such an important role to play in saving and investing for retirement.
All investments carry some kind of risk. Even investments that have lower risk can be affected by forces beyond your control, such as a political event, a strike or a boycott. Probably the most familiar type of investment risk is market risk, which is market volatility that causes the day-to-day fluctuations in a stock’s price. Risk need not always be bad – market events can also cause your investments to increase in value. There are many types of risk and it is worth delving deeper into this topic in order to fully understand the potential pros and cons of investing.
Risk and return
A key thing to understand about investing is that higher-risk investments have potentially higher returns than lower-risk investments. While a lower-risk investment, such as government bonds, tends to be less volatile than stocks, it also does not have the same potential as stocks.
Understanding your risk tolerance
If the thought of losing even a little money over the short-term unsettles you, consider a portfolio with lower-risk investments. Understanding your own risk mindset can help ensure you’re comfortable with your investments and your strategy. Getting educated about the risks and returns of various investments may help you design a more appropriate portfolio that can help you pursue your retirement goals. Consider talking to a Merrill Lynch Financial Advisor about your risk tolerance.
Risk and asset allocation
It’s also important to distribute your portfolio among different types of investments. Known as asset allocation, the idea is to have some money invested in stocks, some in bonds and other interest-earning investments, and some in cash. If one investment type drops in value, the decline will often be offset by gains from another type. And if you have significant gains from one type of investment, consider rebalancing your assets by selling some and putting the proceeds into an undervalued category. This can help you lock in profits and take advantage of investments that are momentarily “low-priced.”
Diversify to help manage risk
If you put all your money into one stock, you could easily lose your investment if the company goes under. To avoid this kind of risk, the key is to diversify. Instead of investing in just one company, spread the money around several. One way to get instant diversification is through mutual funds. Your investment is spread among a portfolio of underlying investments.
How time comes into play for high-risk investments
The time horizon of your investment may also affect how much risk you are willing to take. If retirement is still 30 years off, you may be willing to take more risk and hope that the market gives you a chance to recover from any losses over that time. However, as retirement approaches, you may want to shift to lower risk investments before you need to access your investments.
Whether you choose high-risk or lower-risk investments, it pays to educate yourself and learn as much as possible about the role of risk in investing.
What's next? The benefits of a savings account
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Investing involves risks, including the loss of principal invested.
Diversification and asset allocation do not assure a profit or protect against loss in declining markets.
Neither MLPF&S nor Bank of America, N.A. are tax or legal advisors. It is suggested that you consult your personal tax or legal advisor before making tax or legal-related investment decisions.