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By Ben Baden
By not participating fully in rallies, investors risk missing out on years of compounded returns
When it comes to investing, analyzing the amount of risk you're exposed to can be tricky. On one hand, investors don't want to take on too much risk and lose their hard-earned money, but on the other, they don't want to stash their savings under their mattress and risk not seeing any appreciation over time. Lately, investors have been doing more of the latter -- staying out of the market for fear of losing more money after one of the worst downturns in decades.
Earlier this month, Prudential released a survey in which a majority of individual investors (58 percent) said they've lost faith in the stock market. Every financial decision an investor makes carries risk, so it's important to be aware of how your portfolio is positioned. Here are six risks every investor faces:
This is the most obvious risk. When you invest in stocks or bonds, you run the risk of losing your capital. A closer examination reveals that there is much more to the story than just losing money.
Often overlooked, upside risk refers to occasions when investors are too conservative and miss a rally. "Upside risk is poorly understood, but it's even more detrimental [than capital risk] in some cases to achieving an investor's objectives," says Douglas Coté, senior market strategist at
Having a lot of investments and being diversified are two different things. "Tracking your individual stock exposure is a great idea," says Christine Benz,
Having a diversified portfolio means more than just owning a mix of stocks and bonds. It requires investing in non-correlated assets. By buying uncorrelated assets, an investor reduces his or her overall risk. "When you add a volatile, high-return asset class like emerging markets to a well-diversified portfolio, it both reduces risk of the overall portfolio and increases return," Coté says. Investors with emerging markets exposure benefited from a huge rally after 2008's downturn. And during the market meltdown, long-term U.S. treasuries, a traditional safe-haven asset class, gained 34 percent in 2008, while most other asset classes tanked.
In recent weeks, interest rates on common investments like the 10-year treasury have fallen. Yields remain near historic lows, and rates could remain that way for quite some time. But experts say current 10-year treasury yields of around 3 percent aren't sustainable over the long haul. That means at some point, investors will need to brace for rising interest rates, which can damage fixed-income portfolios. When yields rise, the price of existing bonds fall. The standard rule of thumb is that for every 1-percentage-point increase in treasury yields, investors should expect a bond fund to decline by the amount of its duration, Benz says.
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