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Invest Smarter: Understand Risk and Time Horizon
To protect your investments, you need to understand what threatens them: market risk and inflation risk. You then need to strike a balance between risk and return, given your financial goals.
In almost all cases, risk and return go hand in hand. Return is the change in an investment’s value over time—either positive or negative. Risk refers to an investment’s volatility, or potential for varying returns based on the stock market or inflation.
- Market risk—the day-to-day ups and downs of the stock and bond markets.
- Inflation risk—the risk that you aren’t going to make money above and beyond the inflation rate.
One type of risk trades off with the other. Investments that have greater market risk have greater potential for higher returns over time. Thus, they are less vulnerable to inflation risk. Investments that have lower market risk (more predictable returns) normally offer lower returns over time and are most vulnerable to inflation risk.
How do you balance between market risk and inflation risk?
Use time to your advantage:
- For long-term investments—If you don’t have an immediate need for the money, you can invest more in stocks and accept higher market risk in the hopes of greater returns over the long term.
- For short-term needs—If you need money in the short-term, you’re better off choosing more conservative investments to protect from short-term losses.