Risk and Return:
Investment of any kind comes with a certain degree of risk. From one perspective, the greatest risk is that you may lose all the money you have invested, and more. But there's also the risk that you may earn too little and have to scale back your financial goals.
In general, the risk of losing money on an investment rises as the potential return, or payoff, increases. Or, to put it another way, seeking higher returns requires taking higher risks.
Mitigating Risk:
No investment has a fixed level of risk or guaranteed return. But the way certain investments have performed in the past can often give you a sense of the return you might reasonably expect over a period of time.
With traditional investment classes, such as stocks and bonds, it's easy to check performance history since this information appears in a number of readily accessible financial resources, both online and in print.
In contrast, the return on direct investments is harder to predict. There's less information readily available and a limited range of similar investments that you can compare to the ones you're considering. That's where a financial advisor can help-by explaining the particulars of any new investment opportunity, including direct investments.
Asset Allocation:
Asset allocation is a strategy that involves selecting a mix of investments calculated to achieve your financial objectives at a level of risk you can tolerate. Determining what percentage of your portfolio you allocate to each asset class, or investment category, can be one of the most important decisions you make with your investment advisor.
Some asset classes have the potential to increase the value of your portfolio, and others to provide regular income. Some categories, such as dividend-paying stocks, may do both. But no asset class produces strong returns all the time and, each class will, at times, result in loss.
Asset allocation is based on the theory that each asset class tends to perform somewhat differently at any given time. For example, when stocks are providing a strong return, bond returns often slump. And when investors are buying bonds, stock prices tend to slide. Investing in both stocks and bonds over time may help you avoid the amount of loss you could suffer in a stock downturn if you owned only stocks, or in a bond downturn if you owned only bonds.
Diversification:
To diversify, you spread the investment dollars you allocate to each asset class among a number of securities in that class. Rather than buying just one or two stocks, for example, you invest in companies in different industries or sectors and with different market capitalizations.
Those groups or units within an asset class-which share basic characteristics but also have some noticeable differences-are often identified as subclasses. For example, both small-cap and large-cap stocks are equities, but small cap companies, as a group, tend to be more volatile than large-caps and have stronger growth potential. Large-caps, on the other hand, are more likely to pay dividends and have the resources better equipping them to ride out a market downturn.
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