Risk and Your Retirement
Knowing the different types of investment risk can help you cope with market volatility.When was the last time you checked your retirement plan balance? If your balance was less than it was the last time you checked, you probably felt a bit of pain. Everybody does. Where exactly does that pain come from? It’s called risk, and all investments involve some degree of risk. In finance speak, risk refers to the degree of uncertainty and/or potential financial loss inherent in an investment decision. In general, as investment risks rise, investors seek higher returns to compensate themselves for taking such risks.
Every saving and investment product has different risks and returns. Differences include how readily investors can get their money when they need it, how fast their money will grow, and how safe their money will be. Let’s take a look at the many faces of risk we all experience as investors. While it may not take the pain away, it will at least help you cope a little better with market volatility.
Business RiskWith a stock, you are purchasing a piece of ownership in a company. With a bond, you are loaning money to a company. Returns from both of these investments require that the company stays in business. If a company goes bankrupt and its assets are liquidated, common stockholders are the last in line to share in the proceeds. If there are assets, the company’s bondholders will be paid first, then holders of preferred stock. If you are a common stockholder, you get whatever is left, which may be nothing.
One of the advantages of investing in a stock fund (versus a single company’s stock) in your retirement plan is that business risk is mitigated to a certain degree. Because your money is diversified among several companies, the business risk is spread out. The same can be said about investing in a bond fund versus a single bond issuer (in particular a single corporation).