If you’re a savvy investor, you likely know how to manage risk as you weigh your investment options. But when you’re investing for retirement, it becomes a little trickier depending on how close you are to your actual retirement date and other factors such as the types of investments you hold.
If there are unsettled waters ahead, it becomes even trickier. However, there are potential strategies for you to calm the waves of uncertainty and plot a straighter course toward a more financially stable retirement.
Diversify your investment holdings
The goal of diversifying your investments is to seek to maximize your returns across all investment vehicles while being positioned for various outcomes during a bull market or an economic recession.
Think of diversification as a kind of strategy for uncertain times. When the economy is going well and you’re getting great returns on your money, there’s not as much to worry about. But are you prepared investment-wise to weather rough times like economic downturns?
When you diversify, you attempt to spread out risk as evenly as possible so that negative events don’t impact your retirement goals as severely. For example, suppose you are given a tip by a friend or family member to invest in stock ABC. What happens if that company is poorly managed and goes out of business or is bought out?
One way to manage risk is to spread risk out. One way to do that is to invest in a mutual fund that holds many stocks across many industrial sectors. Many companies that trade in these funds offer investment tools that will guide you on what to expect and how much risk you are taking on by investing in them. Mutual fund investing involves risk, including possible loss of principal.
Remember the old adage “don’t put all your eggs in one basket”? That is the time-honored approach to asset allocation and diversification.
Diversification may help you manage investment risk, but it won't shield you from market risk. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio over the long-term.
Keeping an eye on your statements is perhaps the best way to stay vigilant regarding your investment performance over time. Keep in mind that the very same investments that may be making you money now could also sour during an economic downturn so it pays to be prepared.
Avoid the temptation to make easy money
The proverb “a fool and his money are soon parted” carries a lot of weight when referencing individuals who take unnecessary risks with their retirement investments in order to make what they perceive to be easy money.
While some investments might bring you high returns over a short period of time, it’s generally not a wise long-term investment strategy.
If you are the type of person who enjoys taking investment risks, you may want to use funds that are separate from your retirement funds and allocated specifically for riskier investments—this way your primary nest egg will be better insulated against losses.
Gauge how risk-averse you are
“You don’t concentrate on risks. You concentrate on results, because no risk is too great to prevent the necessary job from getting done.” – General Chuck Yeager
That quote is clearly from the type of person who is willing to take on a tremendous amount of risk for an equally big return. The problem is that not everyone is made from the same cloth as Yeager. Most of us are a great deal more risk-averse and careful with decisions made in our day-to-day lives—especially when it comes to our finances and investments.
When gauging how risk-averse you are, it’s typically a good idea to take a step back and base your decisions on solid research and common sense rather than emotion. You are, after all, taking an active role in managing your investments. Knowing some basic concepts about mutual funds, IRAs, 401(k)s, and stocks will help you determine how much risk you are willing to take on as an investor.
Know what your returns are likely to be
One sound strategy you can employ to manage investment risk is to have an idea of what your returns will be. There is no guarantee, of course, that your expectations will match your exact rate of return, but knowing the definition of a few key terms will give you an idea of how your investments generate returns.
- Yield: This is usually expressed as a percentage of income an investment pays over the course of a year divided by the investment’s price.
- Rate of Return: This is all of the money you either make or lose throughout the time of the investment, expressed as a percentage of the investment’s cost.
- Capital Gains and Losses: This is straightforward. Investments are known as capital assets. If you make money selling one of your assets for a higher price than you paid, it is a capital gain. If you lose money on the sale, then it is a capital loss.
Overall, one way to manage risk when investing for retirement is to have a good sense of how much risk you are willing to take on, knowing which investments are right for you and educating yourself on how your investments make or lose money over time.
To assess your risk tolerance, try our free online Riskalyze tool.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All investing involves risk, including possible loss of principal.