The name of the game when it comes to investing is compound growth. But how much investment risk should we take when we are pursuing growth of our portfolio?
The goal of investing is to have your money work for you to make more money. If you just keep your money in a bank account it is working at 1%, if you are lucky! 1% is lower than inflation which means you are actually losing money when storing your savings in a bank.
In order for your money to expand in value, you have to put it to work and that means investing.
Below is one of my favorite quotes when it comes to risk:
You could run out of food and die.
You could fall off a cliff and die.
You could be attacked by a bear and die.
OR YOU COULD STAY HOME AND FALL OFF THE COUCH AND DIE.
I know, I know, this is not about investing, but the point is there is a risk in everything!
There is no avoidance of risk. For every action you take, there is a risk involved, no matter how small.
As an outdoorsman, I love the above quote, as it really exemplifies the just get out there and do it mentality. Like the outdoors, you just need to get out there and invest wisely.
Risk Taking With Money
Here are just a few of the things you can do with your money ranked in terms of risk lowest to highest using traditional thinking.
- Store your money in cash under the mattress.
- Keep your money in the bank.
- Invest in AAA-rated Treasury Bonds
- Invest in the bond market
- Invest 50/50 bond market/stock market index
- Invest 100% in stock market index
- Invest in self-picked stocks to beat the market.
- Invest in options/derivatives/futures etc.
- Invest in cryptocurrencies and other speculative investments
Somewhere between 5 and 7 falls real estate.
Now the problem with traditional thinking is that options 1 and 2 actually lose you money. Options 1 and 2 are only safe bets if there is no inflation or we are in a period of deflation where your money becomes worth more than it was before.
Raise of hands, who has ever lived through a period of deflation?
Certainly not me. At least never a period of sustained deflation.
The old paradigm is gone. We must adapt to the new times and invest wisely in order to generate wealth. Gone are the days that you could make 5% interest in a savings account. We want our dollars making more dollars that in turn make more dollars for us.
In order to do this, we must assume more risk.
But how much risk is enough?
Obviously, there is a spectrum of investment risk throughout the stock market and investments in general. How much is enough to generate the return you are looking for without risking all you have?
The answer unfortunately is, it depends.
Like so many other things in life, risk depends on many factors and each person has their own risk threshold. Each of us has to decide for ourselves what is enough and too much risk, but I can give you some guidance on how to proceed.
Investing in index funds is the best way to get a good return on investment without risking too much.
Even Warren Buffet, the famed master investor recommends index funds and is setting his wife up with index funds for when he passes away.
Jack Bogle, the founder and former CEO of Vanguard, has this to say about index funds:
“The index fund is a sensible, serviceable method for obtaining the market’s rate of return with absolutely no effort and minimal expense. Index funds eliminate the risks of individual stocks, market sectors and manager selection, leaving only stock market risk.” ~Jack Bogle
With glowing recommendations from 2 of the leading investors of our generation, there is little need to go elsewhere.
Invest in index funds and you will be on your path to financial independence. They are the safest bet, while still generating significant returns on your investments.
Investing in much of any singular entity outside of index funds is speculative. Any individual stock, bond, company, currency, etc. has the potential to fail. The power of the index fund is the fact that it averages it all out and gives a whole market return.
That is not to say there is no place for speculative investments…
Just don’t place all your money into speculative investments. The best advice I have for speculative investment risk is this:
Only invest in speculative investments, whether they are options, futures, derivatives, cryptocurrencies, etc. the amount that you are willing to lose.
You may win big, but you may also fall flat on your face with speculative investments. I have recently started to invest in cryptocurrencies. I even bought an ethereum miner. These are certainly speculative investments, but they total a measly 2% of my investments. Maybe I will raise it towards 5%, but regardless, they are not to be a large percentage of your investments. The amount of risk is just unacceptable.
The investment risk on speculative investments is simply too high to be dependable.
Mitigation of Investment Risk
We now know that investment risk can be mitigated through the smart use of index funds.
Simply the best place to keep those index funds is M1 Finance. M1 Finance has recently gone to a no-fee model making all investments completely free for investors. They continue to make money the way all banks make the majority of their money, through lending and interest payments. However, they do not nickel and dime the lowly investor stealing from our returns.
With M1 Finance, you choose your desired asset allocation either automatically based on risk or you can put it together manually and then M1 Finance takes care of the rest. All of your contributions are allocated to keep a stable investment allocation.
Check them out today! M1 Finance is now free!
Investment risk is something that needs to be undertaken in order to see reasonable gains in your portfolio. Your personal level of investment risk is a decision you will have to make based on how risk-averse you feel. No matter your level of investment risk, you should be investing in index funds to help boost your portfolio for the foreseeable future.
So readers, what are your feelings on investment risk and speculative investing?
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