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The Risk of Investing

May 21, 2008  |  Difficulty: Easy

Dollars for investments
Know What Risk Means

When you invest, it is important to remember there is always a risk. Not every investment carries the same level or the same type of risk. Risk often means a possible loss of principal, but the risk of investing in insured products makes it a possibility that the rate of return won’t outpace the rate of inflation. Although your account balance may increase over time, your buying power may decrease due to the rate of inflation.

Risks Associated with Bond Investing

Bond investing comes with its own set of risks, but a good rule of thumb to keep in mind is that when interest rates fall, bond prices rise, and when interest rates rise, bond prices fall. When the interest rate risk changes interest rates in the U.S. as well as the rest of the world, the market value of your bond will be reduced or increased.

Steps to Assess Where You Are Financially
  • Prepare a Net Worth Statement
  • Calculate Your Debt-to-Income Ratio 
  • Prepare a Cash Flow Analysis. A Cash Flow Analysis, or budget or spending plan, will list your income and expenses by month. You’ll subtract your expenses from your income to obtain your net cash flow. If it’s positive, plan what to do with the excess. If it’s negative or you break even, either find ways to increase your income or cut your expenses.
  • Manage Your Risk. Make sure you or your business is adequately protected in the following ways: buying insurance for your home, business, health and long term disability.
  • Check to make sure you have the lowest possible interest rates on your debt, including your mortgage, credit cards and car loans.
  • Assess your risk tolerance and find out how much risk are you comfortable with.
  • There are lots of online tools that will help you determine your risk tolerance.

If you have investments, prepare an asset allocation analysis, which helps you figure how much you have in stocks, how much in bonds, etc. Make sure you are comfortable with having these amounts invested in these types of investments and that you have your eggs divided up in the right baskets.

The mechanics of investing are pretty straightforward. The process of finding, opening, and funding a discount brokerage account can be broken down into a fairly simple process:
  • Decide how much you’ll invest:
Some brokers require a minimum initial deposit of $2,000, while others may only require $500. There are even some brokers that require no minimum, or they may accept smaller initial deposits to open an IRA. The first step is to figure out how much money you plan to start with.
  • Consider what you’ll be investing in:
Whether it is stocks, mutual funds, options, bonds, or certificates of deposits, it is a good idea to do your homework so you know where you want to invest your money. Not every online broker will offer all of these, so make sure you can buy what you want through your broker.
 
Research Brokers before Choosing the Right one for You

Check out and compare how much different brokers will charge in commissions and fees. It’s important to find out information about trading commissions and to compare account maintenance fees, IRA custodial fees and other costs. Most bond transactions are handled through a broker and the vast majority of brokers are honest and professional. There are organizations like NASD that make sure that the dishonest brokers are identified and disciplined, and possibly barred from the industry. There is more to finding a broker than knowing which ones are trustworthy. The main thing is to find the broker and brokerage firm that make you feel comfortable and the one that will meet your personal financial needs.

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