The goal of investing is not merely to make a profit on your investment but to maximize that profit. One problem that is drubbed into our heads over and over is that we should be careful to find the right risk-reward ratio so we do not overexpose ourselves and lose a substantial amount by choosing high risk investments that do not match our expected return.
The Rising Stock Market Risk Factor
For example, if you decided to take your cash reserves and convert them to stocks one year ago, you look like a financial genius. The stock market started at 18,250 on Election Day, jumped to 20,000 by January 25th, hit 21,000 on March 1st, reached 22,000 on August 2nd, and currently sits at 24,750. That is a 6,500 point move in about a year.
But what if you decided to stay put and hold on to your cash making 4 percent or less? True you did make some money but the question is whether that return on investment met your investment goals. Reducing your risk also reduced your profit and the amount you have for future investments. Whatever investment vehicle you choose, it should be reinvested to continue your wealth building goals.
When Taking No Risk Is A Risk
The risk that you choose not to take is also a risk, strange as that sounds. Your goal should be to manage your risk, not avoid it. It is understandable that many seniors and retirees are very jumpy about the stock market given that too many people lost too much money in the Great Recession of 2007. Though for many that seems like yesterday, a decade has passed and the economic signs, not just the stock market, are showing signs of continuing growth and health. To be honest, playing it safe in this current economy is almost guaranteed to be a mistake.
This is not suggesting that you dive headlong into the stock market – or any other investment. It is a time to acknowledge that if you are retired or approaching retirement, it is time to wade back into the financial waters and test things out – slowly.
Two Major Considerations
Two major considerations of any investment are the after tax and after inflation return you make on your investment. Though inflation has been relatively low over the past decade (in part thanks to the Great Recession) the last reported COLA of 2.0 percent means you lost half of a 4 percent return to inflation. Depending on your investment, the remaining 2 percent can disappear in taxes, leaving you right back where you started – one year later. You can put the cash under your mattress and get the same result.
If you have taken too safe of an approach to your investments, you can start peeking out of your financial window and see your options. The key is to find the right balance of risk and reward that works for your lifestyle. Safety is a relative term when it comes to maintaining your existing lifestyle. There is always the option to lower your standard of living by playing it extremely safe, but for most people who have worked hard to create a retirement plan, moving south is an unpalatable option.
Where that leaves most people is finding a place with moderate risk in an investment that is insured by the U.S. government. The reason for choosing the government insured investment is simple: if the government fails, then we are all in real trouble. Some people have a certain amount of hard currency such as gold or silver should that nasty event actually occur. But for the normal economic scenarios insured investments are safe and have a decent combination of risk and reward.
Closing Thoughts On Investment Safety
One of the more difficult things to do is to estimate how long you will live. Most people as they grow older encounter problems with their health, but you never know what or when. Two numbers you can look at are the expected life span as determined by Social Security and your family history. There are too many factors that can affect your personal longevity to go into detail here, but you should be aware of the general health and lifestyle problems that are likely to reduce these two numbers. For financial purposes, keep it simple. If you want to leave something as an inheritance for your children you will likely want to be on the conservative side of your life span number because if you die sooner than expected your investments will be passed down to your heirs.
Despite all this good advice, the reality is that there are people who are nervous about investing in anything that has anything but a low level of exposure to risk. Do not let other people talk you into investing in financial instruments that will have you up at night worrying about your money. The whole purpose of investing is to make your life easier, not to send you to an early grave. That said, be open-minded about investing. Just remember that a mind that is too open will end up emptying out all the contents.
Written by Garrett Parker
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