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Is there such a thing as not taking enough investment risk?


Don't think of risk only as the possibility that you'll lose your money. Often risk is subtler than that. It can be something less drastic, such as missing your goal by a percent or two. In fact, you can take too much or not enough risk in investing. The key is to navigate a path between the two extremes. Both risk types -- too little or not enough -- are equally perilous.

Why playing it safe can be the riskiest strategy of all

In certain circumstances, secure investments such as short-term deposits and T-bills are fraught with danger. This occurs when they are improperly used as long-term investments, such as a 40-year-old saving for retirement 25 years away. The risk stems from inflation, the number one enemy for anyone trying to grow their money. Inflation pushes up prices, which means a dollar today will buy you less in the future. The worst case scenario is when the inflation rate is higher than the interest rate your investments are paying. If this happens, your investment will lose part of its buying power. Inflation makes a dollar today decline in value over time. To maintain your dollar's buying power, your investment must grow by at least 3% per year if inflation is 3%. Any return higher than 3% will increase your buying power. When you have a long time available before you will need your money -- say 10 years or more -- then you can afford to take on additional risk. Time reduces the higher risks inherent in such investments as stocks. Over the short-term, stock prices can fluctuate wildly. But over time they tend to grow faster than inflation.

Beware of taking too much risk

While having time on your side puts you in a position to take on more risk, it doesn't necessarily follow that this is the best strategy for everyone. What you must to evaluate is whether you need to take on increased risk. If a safer strategy will enable you to attain your goals, then it makes more sense to be conservative. Assuming more risk could mean missing an important goal that is otherwise easily within your grasp, or worse still, cause you to lose money you simply can not afford to be without.