Key Takeaways
- Risk and reward both clash and work together, and are culturally significant here in the US as American investors tend to embrace more risk than elsewhere.
- Risk tolerance is how much you are/are not willing to take a risk on an investment, and there are several types or risk markets you can invest in based on your risk tolerance.
- Your short term and long term goals affect how you allocate your investments.
Bert and Ernie, Spongebob and Squidward, Penn and Teller. These dynamic duos both clash and work together. Likewise, when we look at the market, we think of Dr. Jekyll and Mr. Hyde, good and evil. It doesn’t have to be that way, but that’s the perception.
If we look at the cultural aspect of this, we see for instance, that Europeans tend to be less risky than Americans, and much of that is due to the entrepreneurial environment here in the United States. It’s been borne out by people like Steve Jobs, Jeff Bezos, Mark Zuckerberg and Elon Musk. We look to them and buy more stocks because we believe in that kind of business. But it really comes down to our individual risk tolerance.
What’s risk tolerance? It’s how much you are or are not willing to take a risk on an investment. There are many factors that affect your tolerance for risk, and you may tend to dance back and forth between levels of risk. The fear factor, the things that keep you awake at night, and the fact that you want to have growth in some assets, income or otherwise are all things that affect your risk tolerance.
Let’s look at the risk markets. You have the stock market where, you never know, you could lose everything or make a lot of money. There’s the bond market, which is affected by interest rates and bond values can go up and down. Finally, there’s the cash markets, which many times have guarantees on them, but there’s also no protection from inflation. No matter where you go, you will have different kinds of risks, so you want to look at investing in different places based on your goals and objectives.
To see how risk and reward works, let’s look at the risk ladder. As we go up the ladder, there is increasing risk, with a corresponding increase in reward, but we have to hold on to our investments for five or more years to get the reward we want. Likewise, as we come down the ladder, we get less return for our lower risk, and we only have to hold on to our investments for a year or less.
It comes down to your goals with things such as retirement accounts, which are long term, versus saving for a car, or a house, or a wedding, all of which are short term, and how you allocate your investments based on those goals.
When we look at this dynamic duo between risk and reward, the intersection of these two things is where sitting down, planning it out, and making smart decisions leads to successfully building your wealth.
Until next time, enjoy.
Gary