Choosing the right investment can be overwhelming. With literally thousands of options available, it’s easy to feel lost. While it might be tempting to gravitate towards investments that are gaining a lot of hype and offering the possibility of sky-high returns, this is generally not a great approach. High potential returns often have some high risks, and this might not align with your financial goals. This is why  it’s crucial to have clear goals before diving into investment choices.

If you missed last week’s article, where we went in depth about the importance of setting financial goals, you can read it right here!

Once you’ve defined your objectives, you can begin to narrow down your investment options to those that align with your goals. Sounds a little intimidating? Don’t worry, I’m going to walk you through a few basic concepts that will help  make the process more manageable.

Understand the Difference Between Volatility and Risk

Volatility and risk are terms that are commonly confused in the investing world. It’s easy to see why—both involve uncertainty and the potential for financial loss. However, understanding the difference between them is key to becoming a savvy investor. Think of volatility as the market’s mood swings—sometimes it’s up, sometimes it’s down, but it doesn’t necessarily mean you’re heading for trouble. 

Risk, on the other hand, is like the potential storm clouds on the horizon—it’s the chance that you might not reach your financial destination.

It’s important to note that high volatility doesn’t necessarily mean high risk. For example, utility stocks can be highly volatile due to changes in interest rates and other factors. Despite their price fluctuations, these stocks often provide stable cash flows and regular dividends, which can cushion against market downturns.

On the other hand, investing in a small biotech firm that is developing a new drug can be high-risk. If the drug receives FDA approval and hits the market successfully, the stock price could skyrocket, leading to massive profits. However, if the drug fails in clinical trials or is denied approval, the stock could plummet, resulting in substantial losses for investors. This combination of high potential reward and significant downside risk is what characterizes high-risk investments.

Consider the S&P 500 index, which tracks the performance of the 500 largest publicly traded companies in the U.S. While it experiences regular volatility, on average the S&P 500 has averaged annual returns of 13-14% over the last decade. Think of the S&P 500 index  like the ocean: there are waves that rise and fall, sometimes quite dramatically, but the tides are predictable and steady over time. These waves represent the market’s volatility—short-term ups and downs that can make even seasoned investors sweat a little at times. However, the overall direction of the tide is upward, reflecting the index’s long-term growth and stability. So while it might feel like a choppy ride in the short term, the long-term risk is lower than it seems.

Now that you understand the difference between volatility and actual risk, here are the key ways to manage both within your investment portfolio: 

Diversification: Spreading Out Your Risk

Diversification is a key strategy for managing investment risk. By spreading your money across various asset classes—such as stocks, bonds, and real estate—you reduce the impact that any one investment can have on your overall portfolio. This means that if one investment performs poorly, others may perform well, helping to balance out potential losses. Diversification helps ensure that your portfolio remains more stable and resilient, providing a smoother and more reliable path toward your financial goals. It is arguably the most effective way to protect your investments and enhance your long-term returns.

Here are a few tips to creating a well-diversified investment portfolio: 

Mix Different Types of Investments: Include a variety of asset classes such as stocks, bonds, and real estate. This way, you’re not putting all your money in one type of investment.

Spread Out Within Each Type: For stocks, invest in different sectors like technology, healthcare, and consumer goods. For bonds, consider both government and corporate bonds.

Consider Geography: Invest in both domestic and international markets. This helps protect your portfolio from being too dependent on the economic conditions of one country.

Use Mutual Funds or ETFs: These investment vehicles are naturally diversified because they hold a basket of different assets. They make diversification easier, especially if you’re new to investing or managing your own portfolio using a robo advisor. 

Review Regularly: Periodically check your portfolio to make sure it remains diversified. As some investments grow and others shrink, you might need to rebalance to maintain your desired level of diversification.

Avoid Over-Concentration: Be cautious not to invest too much in a single company or industry. No matter how promising it seems, it’s safer to spread out your capital. 

Time Horizon: Matching Investments with Your Goals

Your investment time horizon—how long you plan to keep your money invested—plays a big role in how much volatility you can handle. If you’re investing for a long-term goal, like retirement in 20 or 30 years, you can afford to ride out the market’s ups and downs because you have time to recover from any dips. This means you can tolerate more volatility and potentially benefit from higher returns over time.

However, if you need your money in a few years for something like buying a house a sudden market downturn could leave you with less money than you need. By choosing more stable, less volatile investments, you help protect your funds from unpredictable market movements and ensure that your money is available when you need it.

Your Tolerance for Investment Risk 

Even if you have a long time to invest and could potentially handle more volatility, you shouldn’t take on more risk than you’re comfortable with. What’s more important than the technical suitability of your investments is that you don’t lose sleep along the way. For instance, if market swings make you anxious you may feel inclined to sell your investment during a downturn, even if it means you will lose money. There’s no shame in feeling nervous about investing, but it does mean you might be better served by choosing more conservative investments, or hiring someone to manage your investments for you so you avoid making costly mistakes. 

Consider Hiring Help 

If all of this seems overwhelming, you might consider hiring help. For those new or nervous about investing, a professional manager can expertly diversify your portfolio, help weather market downturns, and guide you down a path to achieving your financial goals. If you’re someone who’s wary of ongoing or embedded fees, think about consulting a fee-for-advice planner (like me!) once or twice a year. They’ll review and adjust your investments at an hourly rate, blending expert guidance with the autonomy of managing your own finances. 

Have a question? Leave it in the comments or contact me HERE!