Stock Investment – Advice from Experts

Most economists and investment advisers use what is called the risk pyramid to demonstrate the relationship between risk and reward. Although renderings of the pyramid vary, the safest investments are always located at the base of the pyramid, and the riskiest investments are grouped at the top. In all drawings of risk pyramids, risks and rewards increase with each ascending tier. Most versions of the pyramid have four tiers, with the foundation consisting of the safest possible investments, which include savings accounts, money market accounts, and Treasury bills.

Money market accounts are savings accounts in which the individual receives a slightly higher rate of interest than is typical in normal savings accounts (interest is the fee earned by keeping money in the account; it is calculated as a percentage of the total amount) in exchange for agreeing to maintain a higher minimum balance than is required by most savings accounts. Some money market accounts place a limit on the number of transactions an individual can perform. Many people do not consider savings and money market accounts to be true investments, even though both do pay interest and therefore make money for the people who hold them. The interest on these accounts is low, and there is virtually no risk of losing money. The benefit of maintaining such an account is that the person has immediate access to the funds in the account. Treasury bills (also called T-bills) are government securities that guarantee the investor a fixed return (usually about 3 percent of the invested amount) after a short period of time. Many economists regard T-bills as the safest form of investment.

The second tier of the risk pyramid consists of a series of relatively safe investment options, although compared to the bottom tier, the risks are greater and the returns are potentially higher. This tier includes conservative stock purchases and balanced mutual funds. An example of a conservative stock would be shares in a stable, long-standing, corporation, such as General Electric. A mutual fund is an investment that combines the money of several investors and purchases a package of stocks, bonds, and other investment securities. There are many different mutual funds available to investors, each posing different degrees of risk. A balanced mutual fund spreads an investor’s money among safe and slightly less conservative stocks. Investors who purchase these relatively low-risk stocks and mutual funds are advised to adopt a “buy and hold” strategy. This means that, after making the initial investment, the investor should expect gradual growth over a long period of time (about 20 or 30 years).

The third tier of the risk pyramid consists of growth funds. Investors at this level put their money into aggressive mutual funds, riskier stocks (such as shares in a start-up technology firm), and investment real estate. An example of investment real estate would be a rental property. Such investors may hold these investments for a long period of time, but they initiate these transactions with the understanding that they may have to sell quickly.

The top tier of the risk pyramid poses the greatest risks for the investor but often pays the highest, most immediate returns. People investing at this level engage in day trading (the buying and selling of high-risk stock in the same day) and purchase commodities (large amounts of bulk goods, such as crude oil, metals, sugar, coffee, and wheat, which are bought and sold through agencies such as the New York Mercantile Exchange). Trading at this level of the risk pyramid is called speculation.

No matter what type of investment an individual makes, there are always two factors to consider when evaluating risk and reward. The first factor is called the time horizon of the investment, which refers to the amount of time the investor wishes to have his or her money tied up in the investment. Some investors prefer to make an original outlay of funds and than add to that outlay at regular intervals. Such investors tend to benefit the most at the second tier of the risk pyramid. The second factor is called the bankroll, which refers to the amount of money the investor can afford to lose. A wealthy investor with millions of dollars of holdings is best served by investing a portion of those holdings aggressively.

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