Another aspect of risk is volatility. Anyone who's invested in equities and witnessed the undulating nature of the stock market knows that some share prices move more wildly than others. Consider hypothetical utility stock ABC, for example. Its price has fluctuated between $25 and $35 this year. On the other hand, the price of technology stock XYZ has moved between $10 and $50. Stock XYZ's value moves about five times as much and is thus roughly five times more volatile than stock ABC. Some investors conclude that stock XYZ is more risky than ABC because its price fluctuates more.
Should fluctuations make you scratch an investment from your portfolio? Not if you're a long-term investor. If your goals are at least three to five years away, don't let the daily, monthly or even quarterly vicissitudes of your investments sway you. Instead, consider investing in more than one stock in more than one mutual fund with more than one investment advisor. Risk can be controlled by placing funds in investments that don't move in tandem.
Looking for ways to enhance the return on your portfolio? In addition to a broad range of individual investments, consider dividing your funds among different asset classes, including stocks, bonds, cash and real estate. In his book Get Rich Slowly (Macmillan Publishing Co.), William T. Spitz, treasurer of Vanderbilt University in Nashville, Tennessee, notes that over the 20-year period from the beginning of 1971 to the end of 1990, the annual return of stocks, as measured by the S&P 500, averaged 11.1 percent, with two years of fairly substantial losses, 1973 (14.8 percent) and 1974 (26.4 percent). If all your assets had been in the running in the stock market, your 10 percent average annual payoff would have been achieved, but with a fairly bumpy ride. After all, while stocks offer long-term growth potential, they may not generate the present income other investments do. Had you instead divided your investments in thirds, placing equal amounts in stocks, bonds and real estate and then rebalanced annually to keep the investment percentages the same, your return for the same 20-year period would have been 10.3 percent--a much smoother ride.
Is there such a thing as a risk-free investment? "Not on this planet," says Daniel Taylor, managing partner of The Taylor Group, an asset management and consulting firm in Charlotte, North Carolina. "Some things are just riskier than others."
Be wary of investments that promise high returns with little or no risk. Even investments that seem risk-free carry the chance that if they're sold before maturity, you could receive less than originally invested. Investments guaranteed by government agencies or ranked high by rating services may ensure that once purchased, your principal isn't going anywhere. That's the good news . . . and the bad news. Stable, secure investments are great for those seeking income or for those saving for short-term goals like buying a house or saving for a car. If you're investing for the long term, however, these investments may not allow your money to keep up with inflation or may be worth less than you paid if you sell them before they come due.
Remember to take into account the effect of inflation on an investment's return. Say an investment yields 6 percent. Factor in an inflation rate of 4 percent, and the yield is down to 2 percent. If you figure in taxes on the money earned, in the 28 percent bracket, lop off 1.7 percent more. Suddenly, your portfolio is no longer a contender. But what's even more risky, Taylor says, "is not being there, not participating, not diversifying to minimize the possibility of losing big, and sitting on the sidelines waiting for a better opportunity."