Managing Risk

My last post introduced some of the different types of risk you face while investing. A question to ask is, "Why take the risk?" The answer is Reward. In general, the more risk you're willing to take on, the higher your potential returns (but also the bigger your potential losses). For example, a savings account at an FDIC insured bank has low risk, but also low rewards (in the form of low interest rates).

In investing, the goal is to maximize your returns without taking on more risk than you can bear. The best way to reduce risk is to follow the old adage, "Don't put all your eggs in one basket!" The key to reducing risk in investing is diversification.

You can diversify mainly in two ways:

• Diversify Investment Types: Spread your investments out among different asset classes, such as stocks, bonds, real estate, commodities, etc.
• Diversify Within Asset Classes: Diversify stocks by holding different sectors, such as technologies, consumer goods, transportation, etc. Diversify bonds by holding corporate bonds, US government bonds, municipal bonds, high yield bonds, junk bonds. Diversify in real estate by holding residential, commercial or industrial investments, etc.

The best way to come up with a plan to have a diverse portfolio that meets your risk tolerance is to work with an investing professional.