Financial: The ABC's of Risk Reward

Every investor dreams of hitting “the big one” – an investment, usually a stock, that climbs through the roof and makes the investor rich. And while that does happen from time to time, the odds of seeking out a stock that is about to super-perform are about the same as winning the lottery – and potentially much more expensive. A lottery ticket may cost a buck or two, gambling on a single stock can cost a whole lot more, especially if the stock suffers a large loss instead of heading for the stratosphere.

So what's an investor like you to do? You want a good return on your investments – enough to reach your financial goals and a comfortable retirement – at a risk level that makes sense to you both emotionally (you want to be able to sleep at night), and in terms of the rewards you expect and need. How do you achieve this? What kind of portfolio should you construct? To put you on the right path to investing prosperity, here is a simple explanation of the risk/reward potential for a variety of common investments.

Individual stocks: There are two key facts to keep in mind here: First, betting your future on an individual stock is extremely risky. Second, study after study has shown that attempting to “play” the market (that is selling a stock when it hits its peak and/or buying a stock for a terrific price just as it is set to increase in value) is typically much riskier than staying invested in a properly diversified portfolio that, over time, will generate reasonable returns regardless of market or sector ups and downs.

Mutual funds: When you buy securities of a mutual fund, usually your investment is immediately spread across the full portfolio of stocks or bonds that fund owns – very likely many more than you would be able to economically invest in on your own. So, you not only get built-in diversification from a mutual fund, you also typically enjoy reduced long-term volatility compared to investing in individual stocks, and a lower average cost than if you bought individual securities, as well as professional money management. Portfolio funds – funds that invest in a number of underlying funds that are sometimes called “fund-of-funds” – are a solid option here by providing the investor a nearly complete investment program with one investment.

Managed assets: This is a process by which a professional financial advisor helps you construct your portfolio according to your goals and risk tolerance. Some or all of your investments may be placed with portfolio managers who specialize in certain market segments or fund types and use sophisticated processes and models (similar to those used by large pension plans) to keep your portfolio on track and producing smooth returns, over time.

Diversification is the key. It cannot be overstated: When you create a diversified portfolio that includes different types, or classes, of assets (cash investments, fixed-income investments such as bonds and T-bills, equities and mutual funds that invest in these classes), you improve the odds that some will produce strong returns in any economic climate.

There is no ideal diversification strategy that works for every one. Your strategy should be built from your goals, financial situation, tolerance for risk, and time horizons (including your age and family status). A professional financial advisor can help you to put it all together.

(Submitted by Damon Smith, Investors Group Financial Services Inc.) For more information call 888.335.1362.

This column, written and published by Investors Group Financial Services Inc.(in Quebec – a Financial Services Firm), is presented as a general source of information only and is not intended as a solicitation to buy or sell investments, nor is it intended to provide professional advice including, without limitation, investment, financial, legal, accounting or tax advice. For more information on this topic or on any other investment or financial matters, please contact your Investors Group Consultant.

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