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  Investing and Risk

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Investing and Risk

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Congratulations! You’ve developed a system that tracks where your hard-earned money goes and a budget that allows you to save. This might be a good time to consider choices for investing, and letting the money you save make more money and increase your wealth.

Remember that investments increase by generating income (interest or dividends) or by growing (appreciating) in value. You might seek investment guidance from financial experts at your bank, or credible Internet resources. You can join an investment club, where individuals pool their funds to make joint investments.

A critical part of your investment strategy will be your understanding of how compounded interest helps you build wealth faster. Interest is paid on previously earned interest as well as on the original deposit or investment. For example, $5,000 deposited in a bank at 6 percent interest for a year earns $308 if the interest is compounded monthly. In just 5 years, the $5,000 will grow to $6,744!

Risk and Returns

As an investor, you will want to keep in mind that the amount of expected return is based on the amount of risk you take with your money. Generally, the higher the risk of losing money, the higher the expected return. For less risk, an investor will expect a smaller return. For instance, interest paid on your savings, which are insured by the Federal Deposit Insurance Corp. up to $100,000, will generally be less than the expected return on other types of investments such as stocks and bonds, which are uninsured.

Some things to consider when determining the amount of risk that suits you are:

Financial goals. How much money do you want to accumulate over a certain period of time?
Time horizon. How long can you leave your money invested? If you will need your money in one year, you may want to take less risk than you would if you won’t need your money for 20 years.
Financial risk tolerance. Are you in a financial position to invest in riskier alternatives? You should take less risk if you cannot afford to lose your investment or have its value fall.
Inflation risk. Savings and investments are sensitive to the inflation rate. While some investments such as a savings account have no risk of default, there is the risk that inflation will rise above the interest rate on the account. If the account earns 5 percent interest, inflation must remain lower than 5 percent a year for you to realize a profit.

By understanding your financial risk tolerance, you can avoid taking more risk than you should, and equips you to develop a strategy you can stick with.

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