Financial Planning - Risk Vs Reward
 | "Risk" is a term we hear so often, and yet not many of us really know what it really means. Usually, we all think about "risk" as losing money because of a bad investment decision or the economy tanking, like most people have seen happen to our houses.
Financial Planning And sure, this kind of risk is real, yet it is not the only type of "risk" that's out there, potentially waiting to hurt your security. Also, most of us have an understanding that usually, (but not always) the greater "risk" you take, the higher the potential reward. You know, like investing in your brother-in-law's "can't miss" pay phone business, or going short on gold futures on margin. You might get killed, but if the deal works, you might get rich. This rule is pretty solid, but is not always the case. For example, let's discuss the only risk you might be taking, that violates the guidelines of risk/reward. A risk, the most common risk we see people taking, which offers a much greater chance of loss, without the equally greater chance of making money! What risk is? The risk of NOT BEING DIVERSIFIED! Let's explain the simple concept of diversification. It is simply the idea of not putting all your eggs in one basket! We know this sounds like a kindergarten lesson, but please bear with us.Even though being diversified seems like a basic foundation of your investments, Let me tell you that over 90% of the clients we have seen are so poorly diversified that they are at great risk!See, if you have most or all your money tied up in the company you work for, for example, you are at great risk! We see people all the time who work with a company, have all of their insurance benefits with the company, have their profit sharing plan in the company, and own a bunch of the company's stock both personally and in their 401(k) plan or whatever! Or, putting all your money in the market as a whole. We consider this as one investment, if that's all you have, even If you have many stocks inside your portfolio. If your company or the market as a whole sucks wind, you are at great risk! Superannuation Does any of this mean more to you in light of the 2008, and 2011 stock exchange roller coasters? There is little if any potential reward with this family to keep their whole financial security tied up in this one company, a treadmill type of investment.So many people are, taking all equally high potential of reward! This insufficient diversification can be the most deadly risk you can ever take!You must be realistic in your assessment of how you're diversified. You can't think you're safely diversified for those who have money in six different banks! While you've diversified amongst banks, you aren't DIVERSIFIED AMONGST TYPES OF ASSETS! See, true diversification consists of being diversified by the different kinds and forms of investments! For example, someone who has money split up between bank CD's, annuities, life insurance coverage cash values, stocks, bonds, real estate, foreign instruments, etc., etc... holds true diversification! Let's look at an example of how splitting up your money into different asset types could add incredible safety!Assume some investor has $100,000 to get, and one option was to put it into a relatively low risk, low yielding account, as well as in the other case, splitting it up into five $20,000 chunks. And, if two of the five investments in the diversified option don't make anything, and the other three do as shown.Invest $100,000 @ 4% For 25 Years = $219,112 Compared To Diversifying Over 20 Years: Invest # 1 - $20,000 @ Total Loss = 0 Invest 2 - $20,000 @ 0% = $20,000 Invest # 3 - $20,000 @ 5% = $53,065 Invest Four $20,000 @ 10% = $134,550 Invest # 5 - $20,000 @ 12% = $192,926 TOTAL $400,541 Fee for Service Would you see how, even though one investment was a total loss, and one made nothing, this investor still made more income by diversifying! (NOTE- THIS IS AN EXAMPLE Just for ILLUSTRATION PURPOSES, AND IS NOT Supposed to have been MAKING ANY PREDICTIONS OR PROJECTIONS. NO RETURNS ARE IMPLIED OR STATED.) |
