Published March 2004

Two investment mistakes: too much, too little risk

Of all the potential investment mistakes — and there are a lot of them — two of the most common are taking on either too much or too little investment risk. To invest successfully, you need to avoid both of these problems.

For starters, you need to be aware that investing always involves some type of risk. When you invest in stocks, and you sell if they’ve declined in value, you could lose some of your principal. On the other hand, if you purchase investments that are often thought of as “risk free,” such as U.S. government securities, you could lose purchasing power if your fixed rate of return doesn’t keep up with inflation.

In short, you’ll need to find a balance between taking “too much” and “too little” risk. Let’s look at both sides of the issue.

Many people are aware that higher investment returns are related to higher risk, but they somehow feel that they simply won’t suffer losses, or that they’ll supernaturally know the “right” moment at which to sell. The fact is, however, that no one is immune from losses — and nobody can predict the exact moment that’s best for selling. To keep yourself from taking on too much investment risk, consider the following guidelines:

• Know yourself — Make sure you’re familiar with your own investment personality. If you know that you really like to invest aggressively, you may need to “rein yourself in” on occasion, especially if you’re considering “hot” investments, whose recent track record may not be supported by solid fundamentals.
• Know what could go wrong with an investment — Before you buy, you need to understand what could go wrong with an investment. For example, if you’re buying a stock, you need to realize that the company’s management could change, or the company’s products could become noncompetitive. At the same time, you might want to develop an “exit strategy” for selling out of this stock in case your “worst case” scenario comes true. If you’re susceptible to playing it “too safe,” you may want to act on these suggestions:
• Know your time horizon — Many people are frightened away from stocks because of their short-term volatility. And it’s certainly true that, on a daily, monthly or even yearly basis, stock prices can move dramatically up or down. However, for the past seven decades, stocks have always trended up. In fact, from the beginning of 1926 through the end of 2002, the S&P 500 index (this is an unmanaged index and may not be invested into directly) showed a compound annual growth rate of 10.2 percent. So, if you have many years to go until retirement, you should have time enough to “ride out” the ups and downs of the market. As you near retirement, you may want to lower your investment risk somewhat by moving some dollars out of stocks and into fixed-income vehicles — but, even during retirement, you may need to consider some growth elements in your portfolio.
• Know what your goals will cost — You can probably identify your long-term goals: a comfortable retirement, college for your kids, etc. But do you know how much they’ll cost? Once you put a “price tag” on your goals, you’ll quickly see that a “low risk” investment strategy — heavy on certificates of deposit, bonds and money market accounts — likely will not provide the growth you need. Consequently, you can see the importance of adding stocks to the mix.

Ultimately, you must balance low-risk and high-risk investments according to your personal risk tolerance, your long-term goals and your time horizon. In the end, you don’t want high risk or low risk. You want intelligent risk.

Eric Cumley is an investment representative with Edward Jones Investments at 1201-C SE Everett Mall Way in Everett. He can be reached at 425-353-2322. Edward Jones is an NYSE-member investment firm with more than 8,000 locations nationwide.

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