Financial Planning - Risk Vs Reward

"Risk" is really a term we hear so often, and yet not many of us really know what it means. Usually, we all think about "risk" as losing money because of a bad financial commitment or the economy tanking, like we've all seen happen to our houses.

Financial Planning

And sure, this type of risk is real, yet it is not the only type of "risk" that's out there, potentially waiting to hurt your security. Also, just about everyone has an understanding that usually, (but not always) the more "risk" you take, the higher the potential reward. You know, like investing in your brother-in-law's "can't miss" pay phone business, or going short on gold futures on margin. You can find killed, but if the deal works, you can find rich.



This rule is fairly solid, but is not always the case. For instance, let's discuss the only risk you might be taking, that violates the guidelines of risk/reward. A risk, which is the most common risk we see people taking, and that offers a much greater chance of loss, without the equally greater chance of making money! What risk is? The risk of NOT BEING DIVERSIFIED! Let's explain the easy concept of diversification. It is simply the idea of not putting all your eggs in a single basket!



We know this seems like a kindergarten lesson, but please bear around.Even though being diversified sounds like a basic foundation of your investments, I will tell you that over 90% of the clients we have seen are so poorly diversified that they are at great risk!See, for those who have most or all your money tied up in the company you work for, for example, you are at great risk! We have seen people all the time who work for a company, have all of their insurance benefits with the company, have their profit sharing plan from the company, and own a lot of the company's stock both personally as well as in their 401(k) plan or whatever! Or, putting all your money in the market as a whole. We consider this as one investment, if that's all you have, even If you have many stocks in your portfolio. If your company or the market as a whole sucks wind, you are at great risk!



Does any of this mean more to you considering the 2008, and 2011 stock market roller coasters? There is little if any potential reward for this family to keep their whole financial security tangled up in this one company, or one type of investment.So many people are, taking all equally high potential of reward!

Superannuation

This lack of diversification can be the most deadly risk you can ever take!You must be realistic in your assessment of how you're diversified. You cannot think you're safely diversified if you have money in six different banks! While you've diversified amongst banks, you ARE NOT DIVERSIFIED AMONGST TYPES OF ASSETS!



See, true diversification consists of being diversified by the different types and forms of investments! For instance, someone who has money split up between bank CD's, annuities, life insurance coverage cash values, stocks, bonds, real estate, foreign instruments, etc., etc... holds true diversification!



Let's look at an example of how splitting up your money into different asset types could add incredible safety!Assume some investor has $100,000 to invest, and one option was to put it into a relatively low risk, low yielding account, as well as in the other case, splitting it up into five $20,000 chunks.



And, if two of the five investments within the diversified option don't make anything, and the other three do as shown.Invest $100,000 @ 4% For 25 Years = $219,112 Compared To Diversifying Over 20 Years:



Invest # 1 - $20,000 @ Total Loss = 0

Invest # 2 - $20,000 @ 0% = $20,000

Invest # 3 - $20,000 @ 5% = $53,065

Invest # 4 $20,000 @ 10% = $134,550

Invest # 5 - $20,000 @ 12% = $192,926

TOTAL $400,541

Fee for Service

Would you see how, even though one investment was a total loss, and one made nothing, this investor still made more income by diversifying! (NOTE- THIS IS AN EXAMPLE ONLY FOR ILLUSTRATION PURPOSES, AND IS NOT Supposed to have been MAKING ANY PREDICTIONS OR PROJECTIONS. NO RETURNS ARE IMPLIED OR STATED.)