We'd all love to get high returns with no risk, but in the real world that doesn't happen. If you think it does, the next Bernie Madoff would like to meet you. • A better approach is to accept that some risk-taking is inevitable. The key to doing it right is to figure out what kind of — and how much — risk you're able and willing to handle. Contrary to some popular opinion, it's not all about how old you are. Here are factors that are more important than age:
How much do you rely on your investments to meet your basic living expenses? If you've got the basics covered through Social Security, pensions and life annuities that guarantee payment over your lifetime, you can afford to take more risk with your investments. If you don't, you should either take less risk with your investments or consider a life annuity to fund the basics.
If you are married, what happens when one of you dies? What will be the financial position of the remaining spouse? If it's likely to be precarious, you may be able to get life insurance to fill the gap. If not, you might consider buying an annuity that pays out as long as one of you is alive.
Do you have a separate emergency fund or cash reserve to handle irregular expenses such as household and vehicle repairs, insurance deductibles and appliance replacement? If not, be sure you are keeping enough in relatively safe investments to cover those costs.
What kind of insurance do you have? Life? Disability? Long-term care? The more comprehensive your insurance coverage, the more risk you can afford in evaluating your investments. But the more exposed you are, the more you need to set aside in cash or low-risk investments.
How soon might you need to spend the money? For some people, the answer is "never." Some take only income from their investments and others never touch their money. Those people can invest for the long term on behalf of their heirs. But if this is money you'll be using to buy a car next year, you're in the opposite category — you're a short-term investor who needs safety and liquidity.
How's your psychological makeup? Ask yourself how much of your money you're honestly comfortable putting at risk, then don't go over that amount. If the thought of losing money gives you a panic attack, if you freak out every time you hear the market is down or if you check your investments incessantly, aggressive investing is out of the question for you.
Many of us experienced firsthand the pain of loss during late 2008 and early 2009. I hope we all learned something about our comfort level with risk as a result. Did you sell investments and then miss out on the rebound?
One way to avoid a repeat mistake is to adopt mental accounting. Think of your investments as being in separate imaginary buckets even when they are mixed together in the same account. You can have a "safe" bucket of certificates of deposit, money market accounts and high-quality bonds, and a "growth" bucket of stocks, stock funds and lower-quality bond funds. You choose the balance you want between those two buckets and periodically move money from one to the other when things get too far out of line.
Most risk-reduction methods involve some cost — you either pay an insurance premium or you accept a reduced return on your money. Bank CDs and their pitiful yields are an obvious example. However, some types of risk, notably the risk of something bad happening to a specific company or industry, can be reduced simply by diversification. That means spreading your money around and not concentrating it in one or just a few companies' securities or in any single industry.
Keep in mind that no investment is completely risk-free. As the wrangling over the debt limit reminds us, government guarantees are only good if Congress puts up the money to fund them. Lower-risk investments — meaning those that are less volatile — also are more vulnerable to inflation risk. Their low returns may not keep up with rising costs, which is why most of us should have at least some growth investments, too. Just be sure the risks you take are right for you.
Helen Huntley is former St. Petersburg Times personal finance editor and currently a fee-only financial adviser with Holifield Huntley Financial Advisers in St. Petersburg (holifieldhuntley.com).