Should You Stick to Safe Investments or Seek Higher and Riskier Rewards?
The success of an investment is determined by how well the investor manages the risk versus the reward. This is the defining characteristic that separates gambling from investing. Gamblers take chances. Investors evaluate risk and understand it. Most casual or semi-professional investors play it safe. That is to say, they invest in assets or securities where risk is lowest. For example, casual investors are most likely to invest in certificates of deposit, bonds, and blue chip stocks. Investors are encouraged to aim for the lowest risks, especially when it comes to retirement saving. Regulations that govern IRAs, in particular, prevent investors from funding certain high-risk assets, but should you stick to the rules? Low-risk investments may protect your principal, but the rewards will most likely be low. It would take years for a low-risk investment option to be truly lucrative. On the other hand, the return on high-risk investments can be astonishingly high. If you have an expanding investment portfolio, you may wonder whether it would truly be worth it to take on more risk.
Would a Potential Loss Be Hedged by Another Asset?
An investment hedge is an asset that protects the overall portfolio from a total loss if an investment fails. Gold is considered a traditional hedge, which protects portfolios from the rare occurrence of a depreciating dollar. In simple terms, if the risky investment you want to undertake fails, would there be an asset class that could protect your total wealth against that loss? If the answer is no, then investors should not take on higher risks. If a risky investment threatens your entire portfolio, then it’s a no-brainer that you should avoid it.
Evaluate the Legal Risks Too
When assessing the risk of any asset class, don’t just consider the business risk. Most casual investors forget the legal or political risk of investments. For example, marijuana stocks right now seem highly promising. The market and the consumer base is ready for cannabis-based products, however, the government may not be. While there is widespread support among the public for cannabis products, the policies of the current administration is not particularly pro-pot, so investments in this sector in the future may face law enforcement roadblocks. Therefore, this type of risk must be considered in your overall decision process.
Could a Potential Loss Have a Domino Effect?
Needless to say, a risky investment should never affect your other investments. Don’t let the risk associated with one asset class have a domino effect on the others. For example, too many junk bonds or risk brought on by scams could affect your entire portfolio. A savvy investor would do more research before taking on risk just because they can. The bottom line is, higher risk is perfectly fine as long as you can afford it. If your portfolio includes assets that can reliably generate returns, then branching out to a riskier venture may sound only natural. If a potential loss can be covered by the returns of rest of your investments, then more risk is not necessarily bad, but if your principal is limited, your options are too. In such a scenario, consider investments that generate only mild to moderate risk.