Not all investors are created equally. Some are the aggressive, make-me-rich-quick kinds, who want to make a killing on their investments. They rarely do, or at least not for long, mind you, but they're sure willing to give it a try. This type of investor is the person at the amusement park who has to go on every roller coaster twice, except for the really big one that loops upside down. He has to go on that one three times.
Other investors are the middle-of-the-road kind. They want something that will be kind of exciting, but nothing too dangerous. They'll risk the tilt-a-whirl at the amusement park, but say “no, thanks” to the roller coasters.
Then there are those investors who just want a nice, safe place to put their money. They don't expect to get rich from their investments, but they want to feel confident that their money will do okay in them and the investments will provide some security down the road. These are the people at the park who love the carousel and think that the Ferris wheel is about as much excitement as there should be in life.
The following risk pyramid shows various investments and how the industry rates their risk of principal loss:
Each of these categories has risks and rewards. Let's have a look.
People can be high-risk investors by choice, or as in most cases, they can be high-risk investors because they don't know enough about what they're doing. A high-risk investor is generally classified as someone who can live with losing about a quarter of his or her investment portfolio in a year.
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Your investment portfolio is the listing and value of all your investments.
An investment portfolio is the listing and value of all your investments. If you have $10,000 to invest, and the thought of losing $2,500 doesn't give you chills, you might qualify as high-risk. But even if you're a high-risk investor, you still have to do your homework and find out where your money has the best chance of earning you more. There's a big difference between high-risk and just plain stupid.
Suppose an investor chooses to be high-risk. He jumps into the stock market and buys only investments with potential for very high returns. He got a hot tip from a buddy of his that a certain industry is about to take off, so he loads most of his money into that industry's stock. Even if this guy knows what he's doing, he's a daredevil. But if he's making high-risk investments because he hasn't done his homework and doesn't understand the importance of diversification or that his money should be spread around, he's risking catastrophe; he's speculating.
Speculating, like gambling, is taking chances and rolling the dice to try to make a killing in the market quickly. Getting a hot tip at a cocktail party and acting on it by putting down $5,000 is speculating. Investing is buying 100 shares of Microsoft stock after you've investigated exactly what the company does, the fundamentals (explained later in the chapter), and the company's outlook for the future.
If you're a moderate-risk investor, you won't bet the farm on a tip you overhear while you're getting your hair cut or sitting in the sauna at the health club. You're generally classified as a moderate-risk investor if you figure you can stand to lose up to 15 percent of that $10,000 in your portfolio. The thought of being out $1,500 doesn't make you jump up and down, but it won't keep you up every night either.
Conservative investors are the meat-and-potatoes people of the investment world. Keep your fancy appetizers, your cream sauces, and your puff pastry desserts. Just give these folks something they can depend on, something that won't give them any surprises, and something they don't have to worry about. They don't want to take any chances with their investments and will gladly give up even the possibility of high returns to know that their money will be there when they want it.
Conservative investors generally start having nightmares at the thought of losing even 5 or 6 percent of their portfolios over a year's time. The thought of losing $600 of that $10,000 investment sets their hair on end.
Your Timetable Is Important, Too
After you've figured out your investing personality, you need to think about your timetable. How long do you want to leave your money invested? One year? Three years? Ten years?
Your timetable has a lot to do with the way you should invest. Traditionally, investments with the potential for higher return are more likely to go up and down in value. That means you should be prepared to leave your money in those investments over a longer period of time. They're not short-term investments because you can't count on them being where you want them to be when you're ready to take your money out.
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If you're investing money that you'll need within two years or less, you're generally considered a short-term investor. Investing your money for two to seven years puts you in the mid-term range. If you won't need your money for more than seven years, you're considered a long-range investor.
If, for instance, you're investing money that you want to use for your wedding the next year, you shouldn't buy volatile stocks that could go anywhere during the next 12 months. You'd want something safe that would allow your money to grow but wouldn't risk your principal. On the other hand, if you've just had a baby and want to put some money away for college, you know you have 18 years. That gives you a much better opportunity to ride out some storms and take advantage of the potential for high returns. As you can see, there are many variables when it comes to investments and investors.
One thing, however, is constant. Regardless of the type of investor you think you are, you need to know what you're doing. If you depend on an investment advisor to lead you by the nose through the world of stocks, bonds, and mutual funds, you'll never be in control of your financial situation. We're not suggesting that you'll never need help with investing or in other areas of your personal finance, but to hand all the responsibility over to someone else is to relinquish your control. Presumably, you've worked pretty hard to earn your money. Why would you let somebody else climb into the driver's seat and take off with it?