You work hard to earn a living, but if you’re new to investing you might be wondering how exactly your money can go to work for you. At Whitaker-Myers Wealth Managers, we take a holistic approach to financial planning. Measuring risk is a critical step in establishing your financial goals. In this article, we’ll talk about the different types of risk to be aware of with regard to your investments.
Keeping the Cash
It can be a common misnomer that cash (or simply a savings account) is the best way to protect your money from the uncertainty of the stock market. While cash can be a smart strategy, it all depends on your objectives. If you are young, in good health, and have a long-term time horizon, then keeping your money in cash is not your best bet. The biggest reason for this is a word we’ve heard at nauseum in 2022: inflation. Keeping your money in cash not only strips it of its potential for growth, but it leaves it subject to inflation risk. As your money sits in the bank, it slowly loses purchasing power over time. As the monetary unit drops in value, your dollar today buys less as time goes on. Think about the soda fountains of the 1940s where a bottle of Coke cost a nickel. Now, that same soda would cost you as much as $1.99. To be clear, regardless of your situation it’s important to have an emergency fund and take advantage of a savings and checking account. Some banks even offer favorable interest rates for certain account balances.
If you are close to retirement, the preservation of capital might be of utmost importance to you. In that case, cash and/or cash equivalents may be right for you. Money market funds, bank certificates of deposits (CDs), and cash might be wise for you – which is why it’s important to talk to a financial advisor about your objectives and risk tolerance.
Letting your money work
Equities, or as most people know them, stocks, have the potential for growth, as well as loss. Equities are shares of a company, and by buying those shares you become a partial owner of a company. Depending on the type of company, you could even receive quarterly payments called dividends, for simply maintaining your stake in the company. Because you are investing in a company, you are taking on what’s known as “business risk.” Whether it’s a new company, a company in poor financial shape, or one going through a reorganization, there is the chance that your shares could drop or experience a complete loss in value (If the company folds). This is not meant to scare you away from equities, but rather, encourage diversification.
Owning equities can be a great way to participate in the growth of companies, but owning too large a percentage of one company, relative to your portfolio, should be avoided. A great way to own equities, and remain diversified is to own mutual fund shares. A mutual fund is a security that invests across several publicly traded companies in order to minimize an individual investor’s risk. As our friend Dave Ramsey likes to say, “Money is like manure: Pile it up and it stinks, spread it around and it'll grow stuff.” If you want to grow your money over the long term, then diversification is your best friend. There are other ways to diversify using equities, like investing in Exchange Traded Funds (ETFs). Talk to an advisor about what might be right for you.
Somewhere in Between
Goldilocks wasn’t wrong. If you are close to retirement or have a greater need for liquidity, then a portfolio heavily weighted in equities might not be the best for you, nor does it really allow you the time to let your money work. Cash and cash equivalents may be among the safest of investments, but they provide little to no return on your investment. Fixed income might be the most suitable for you if you‘re looking to strike the balance between safety and return. Fixed income like bonds and U.S. treasuries are debt obligations that make you the lender and the issuer the debtor. As an incentive, like on any loan, the lender gets to collect interest payments, and eventually a return of the principal. The higher the interest rate, the higher the semi-annual payment you receive as the owner of the debt. In an economic environment like the one in which we are in 2022, this type of security can pay handsomely.
Government-backed securities like U.S. treasuries are backed by the “full faith and credit” of the U.S. government, which means, you can expect you will receive your principal back when the bond matures, or when it is called in early. Of course, every security has some type of risk – even the safest ones. When a bond gets called it means you miss out on future interest payments. Usually, this means that interest rates have come down, and the debtor is looking to sell bonds at a higher price, and pay less interest. If a bond has call protection, or simply no call feature attached to it, then it is going to last until maturity. This means that your money (principal) is locked up until the maturity date, subjecting it to liquidity risk. If you need money in six months to purchase a home, then it would be unwise to purchase debt securities with maturities of nine months. An alternative is to invest in fixed-income mutual funds or ETFs, which provide the liquidity of equity securities.
Being aware of your risks and investment constraints is essential to developing both your investment strategy and overall financial plan. Your needs are unique to you and at Whitaker-Myers, we listen to those needs and make plans that suit our clients. If you’d like to talk about your financial objectives, schedule a meeting with me today.
MEASURING YOUR RISK BEFORE INVESTING
November 10, 2022
Whitaker-Myers Wealth Managers is an SEC-registered investment adviser firm. The information presented is for educational purposes only and intended for a broad audience. The information does not intend to make an offer or solicitation to sell or purchase any specific securities, investments, or investment strategies. Investments involve risk and are not guaranteed. Whitaker-Myers Wealth Managers reasonably believes that this marketing does not include any false or misleading statements or omissions of facts regarding services, investment, or client experience. Whitaker-Myers Wealth Managers has a reasonable belief that the content will not cause an untrue or misleading implication regarding the adviser’s services, investments, or client experiences. Please refer to the firm’s ADV Part 2A for material risks disclosures.
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