No Such Thing as Risk Free Investing
The question of risk is always an interesting one when it comes to portfolio design. Questions such as how much risk do I need? How do I avoid risk? And Why do I need risk? Are all common questions that come to mind. The question of risk and volatility are very important topics in investing to address. The popular phrase “high risk high reward” usually comes to mind and while it does hold true for some cases remember it is not always a guarantee.
The whole goal at the end of each year and really over the long term is to outperform the risk free rate on money. (If you fail to grow your money by at least the risk free rate then your strategy has gone off track somewhere). The risk free rate is the rate you earn on your savings at the bank or lending institution as well as the rate earned on fixed income security like government bonds. Although these are practically riskless, remember that riskless is also very low and the chances of you reaping the compounding benefits are next to none (depending on interest rates). So investors turn to other vehicles. As an investor you should always address your risk premium which is the expected return on stocks (or others) minus the risk free rate. So If I want a six percent return annually and the bank pays me 1% interest - the stock needs to return 7%. It is always important to set aside your risk premium as this will really help guide your investing decisions.
Pro-Tip: When meeting with advisors it's especially important to set out your expectations from the get go and see where the advisors past performance lies. If the advisor can only get you 4-5% consistently and the risk-free rate is 2% on a GIC for example (PREMIUM = 2%) then it may be time to think about switching advisors or investment vehicles.
Remember the reason people avoid the risk free rate is because it does not grow your money over the long term and in many cases you end of losing money because inflation will erode your purchasing power. While it is more suitable for an emergency fund - I would not find it suitable for my long term investments.
The second thing I want to address is the concept of volatility. In the non-statistical definition - volatility refers to the amount of unsureness or risk about the changes and size of changes of an asset’s value. For example, cryptocurrencies are highly volatile because it sometimes goes through immense changes very quickly and drops and increases throughout the day. Since it also trades 24/7 it is more volatile. Penny Stocks are another example because of high volume (demand) propping the price up. While the market is not highly volatile remember that the market is influenced by other factors such as emotions, market news, world news and natural disasters. While volatility cannot be completed eliminated there are some ways to reduce it. A great way is called Dollar Cost-Averaging or DCA which is the process of investing a sum of money gradually as opposed to in a lump sum. The advantage of this is by investing gradually it allows you to capture different time periods in the market to gain from price changes. Additional value is gained because with DCA you do not need to worry about the highs and the lows or trying to determine (time) when the right opportunity strikes.
Disclaimer: All of the above information is my own personal opinion. Please do your research and consult with a licensed representative before making any financial decision. All examples are for learning purposes.
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