DO NOT LET FEAR HOLD YOU BACK FROM INVESTING. If you’re not careful, putting off investing will turn into weeks, months, and YEARS that you could have been BUILDING YOUR WEALTH.
HOWEVER Risk is a crucial topic for beginners to understand. You will hear terms like risk appetite, risk tolerance, and risk capacity. Let’s start with an explanation of these and other relevant terms.
Risk appetite and risk tolerance are somewhat similar but not interchangeable. Risk appetite generally refers to the level of risk you are ready to take. For a beginning investor, your risk appetite will depend on your existing assets, goals, and age. Risk tolerance usually means the acceptable deviation from your investment philosophy. A helpful illustration of the difference is speed limits. The governing organization sets a speed limit for a particular road based on safety, traffic flow, environmental issues, and more. That limit reflects the speed appetite. Often, the law enforcement agency won’t issue a violation notice to drivers exceeding the speed limit by a small percentage. That leeway is the speed tolerance.
Finally, risk capacity refers to your realistic ability to lose money. You may want to be an aggressive investor, but no one should risk losing money that they need to live on. If you have higher assets, you have a greater risk capacity.
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How much risk do I need to take?
Every investment has risks, but some have a higher risk. Often, the investment with a higher risk offers the potential for a greater return. The danger is that you lose money when your goal is to earn money. For example, if you buy shares of stock at $10 per share, you do so in the hope and maybe the expectation that the shares will increase in value. It’s possible that you may also anticipate that the company will pay a dividend, and you can either reinvest the money or use the dividend as cash flow. The risk is that the stock shares will be worth less when you try to sell them. The risk level is the probability of losses versus gains.
If you have an aggressive risk appetite, you will more likely invest in individual equities. In contrast, a more conservative investor will likely diversify their portfolio between stocks and bonds or choose a mutual or exchange-traded fund.
Bonds are debt instruments issued either by governments or corporations. In either case, the return is fixed, which is why bonds are often called fixed-income investments. As a result, you have less risk with bonds, but you also have lower potential returns than with stock investments.
The beauty of a mutual fund, especially an index fund, is that the fund managers do all the work of balancing the investments. If your index fund owns every stock in the S&P 500, the risk of losing money is less because one or two companies lose value. You won’t benefit as fully from a successful, rising stock, but you won’t lose as much when a component stock drops.
The simplicity is one reason that renowned investor Warren Buffett believes that most people are better off investing in an index fund than choosing individual stocks. Other financial advisers agree, also suggesting that you consider a target-date mutual fund. Those funds are available from investment managers and online. The idea is that you choose the fund based on the date you expect to need the money—potentially your retirement or another significant milestone—and the fund manager selects the right combination of investments to work toward growth while decreasing risk as you approach the date.
What about investment apps and robo-advisors?
Investment apps and robo-advisors are automated ways to get limited guidance without spending a ton of money hiring an investment manager. In either case, you complete a profile that includes your investment goals, timeline, risk appetite, and available assets. Then, the advisor (or artificial intelligence) selects and obtains the best investments for you. While there is a cost, it’s often less than the cost of executing a trade personally since you might need to pay a fee to do that.
What’s the right balance for a beginner’s portfolio?
Remember, your investment strategy depends mainly on your risk appetite. If you want to increase your holdings significantly quickly but aren’t afraid to lose money, you can invest aggressively. On the other hand, if you don’t have a cushion, you may want to focus on more conservative investments. A 60/40 portfolio is often recommended for moderate risk. That means you would have 60 percent of your assets in stocks or similar instruments and 40 percent in fixed-income vehicles like bonds. The stocks have a greater chance of increasing in worth but can also lose value. The bonds provide a cushion in case the stocks do decline.
It’s helpful to note that the difference in return between a 60/40 balance and an 80/20 (which would be termed aggressive) isn’t that significant over the long term. From 1926 to 2020, the typical 80/20 average return was 9.61 percent. Over the same period, a 60/40 balance returned an average of 9 percent. A portfolio fully invested in stocks (no cushion for bonds) returned over 10.2 percent in the timeframe. Still, that 100 percent stock-invested fund lost over 43 percent in its worst year. That’s an example of the wisdom behind balance.
Don’t forget about real estate.
As a beginning investor, you may not yet have the assets to buy commercial buildings or even a single rental property. However, that doesn’t mean you can’t enjoy the potential benefits of real estate investments. Consider real estate investment funds, which allow you to own fractional portions of high-quality commercial properties—selected, obtained, and managed by a sponsor. Real estate funds offer the convenience of equity investing with the potential of real estate appreciation—without the hassle of being a landlord.
We had an amazing discussion on this topic and what the absolute BEST ways to invest $5,000 in TODAY’s market.
In the video we got through a step by step process of where to put your $5,000, and why each strategy WORKS in the complicated world we’re all investing in today.
President of Saint Investment Group
Nic is a two decade seasoned expert in investing and capital raising, specializing in Real Estate and debt markets. With Saint Investment Group, he leads large-scale distressed asset purchases and innovative syndications for investors.