Managing risk
Understanding the types of risk is the first step to selecting investments for your retirement portfolio.
Types of risk
Stocks and bonds carry three major risks. Let’s take a brief look at them.
Market risk: The daily rise and fall of stock and bond values. Sometimes the day-to-day changes are small; at other times, they can be dramatic.
Interest-rate risk: Interest rates influence the cost of borrowing money for companies and governments. Fluctuations in interest rates can pose a risk to the value of the bonds issued by these groups.
Inflation risk: The cost of goods and services rises over time. Inflation decreases the purchasing power you’d get if you cashed in your investment returns. If the rate of inflation exceeds your investment returns, your money is losing value.
See Understanding risk for a more detailed discussion.
How to deal with risk
Risk is a natural part of investing. Here’s how to manage it to your advantage.
- Diversify — By investing in a number of securities, you reduce the effect of fluctuations of individual investments. Losses in some holdings may be offset by gains in others. Investing in mutual funds is one way to diversify. You can also choose different types of investments or mutual funds to increase the effect even further.
- Keep perspective — Don’t obsess over the daily ups and downs of your investments. If your goals are long-term, stay focused on them. The goal for most people saving for retirement is to have enough money when they leave the workforce.
- Don’t stop saving — If you stop investing or withdraw money during market declines, you could miss an opportunity to participate in an eventual recovery. Regular investing doesn’t ensure profits or prevent losses, but the market’s history of growth over long periods should make you feel better about staying invested through the ups and downs.
Balancing risk and return
Generally speaking, the more risk you take on, the greater the potential for higher returns. Risk and return go hand-in-hand — you can’t have one without the other.
Your challenge is to find the right balance between investments risky enough to produce sufficient returns, and investments conservative enough to preserve your assets — and your peace of mind. Your choice of investments should reflect that balance.
Return to topInvestors should carefully consider the investment objectives, risks, charges and expenses of the American Funds. This and other important information is contained in each fund’s prospectus and/or summary prospectus, which can be obtained from your plan’s financial professional or downloaded and should be read carefully before investing.