The Elements of an Investment
Part I – Risk

Risk —"the possibility of loss; a dangerous element"—as defined by Webster's New Collegiate Dictionary, is present in every investment. However, you cannot eliminate risk by just not investing. In fact, allowing the possibility of risk to prevent you from choosing any investment is the riskiest decision of all.

Understanding that every investment carries some element of risk, the amount of risk you are willing to accept is known as your risk tolerance. It may seem cliché, but the surest sign that you have exceeded your risk tolerance is losing sleep because of an investment. As you might guess, risk tolerance is an individual measurement; what may be too risky for one person, might be an appropriate investment for another. Equally, your own risk tolerance may change as you move through the different ages of your life and stages of the wealth cycle.

Let's define the various kinds of risk.

Market Risk. This risk is caused by factors in the overall market, such as political, economic and social events. For example, common stock prices overall may fall because of expectations of lower corporate profits in general, even though particular companies continue to have favorable financial positions.

Interest Rate Risk. Caused by fluctuations in the general level of interest rates, bonds are particularly susceptible to this risk. For instance, when interest rates rise, the price of existing bonds will fall; the converse is also true.

Purchasing Power Risk. Also known as inflation risk, this is associated with the loss of purchasing power when general price levels increase. Think of an investment as an alternative to purchasing goods or services. If prices rise while you hold that investment (and the investment does not appreciate in value to keep up with that increase) you will have lost purchasing power when you divest yourself of the investment.

Exchange Rate Risk. You encounter this risk only when you invest in anything valued in a foreign currency. Fluctuations in the exchange rate with U S Dollars could expose your investment to devaluation.

Liquidity Risk. Although liquidity is a separate element on our chart, it is also a risk associated with any given investment. You assume some risk based upon the ease or difficulty in selling an investment in a short period of time.

Certain categories of investments are more susceptible to certain kinds of risk. Publicly traded stocks are subject to market risk. Fixed income investments such as bonds, treasuries and savings accounts are prone to interest rate risk. An investment that cannot appreciate in value carries purchasing power risk. And, any investment that has no readily available secondary market (such as some limited partnership investments or stock in closely held businesses) is predisposed to liquidity risk.

Once you have identified the kinds of risk associated with a particular investment, you are ready to rate its risk element. However, keep in mind that all nine elements on our chart are interrelated. Any single investment will carry more risk (a lower rating) if it does not meet your needs in the other eight areas. Further, there are ways in which you can increase an investment's risk rating.

The first is through diversification. While investing everything you have in an oil and gas limited partnership might be too risky, you may want such an investment included as a portion of your overall portfolio. Thus, you mitigate its low rating on our chart when you combine this investment with a variety of others.

The second way to increase an investment's risk rating is to thoroughly know about that investment. For example, if you are intimately familiar with real estate in Palo Alto, investing in a rental property here will carry a better risk rating than the same investment in property in, say, Florida.

Just as with the other eight elements, the risk element of an investment is a personalized rating designed to assist you in the process of choosing your investments. As we continue our exploration of the other elements, you will see that simply choosing an investment with no risk (a high rating) may not be right for you. When combined with the other elements, you may find the appropriate level of risk that will meet your overall financial goals. Then you can truly choose the investments that are right for you.

Elements of Investment
Elements	Savings & Money Markets	Stocks	Bonds	Limited Partnerships	Real Estate	Commodoties	Home
Risk	8	6	7	2	5	2	9
Management	-	-	-	-	-	-	-
Flexibility	-	-	-	-	-	-	-
Liquidity	-	-	-	-	-	-	-
Cash Flow	-	-	-	-	-	-	-
Rate of Return	-	-	-	-	-	-	-
Appreciation	-	-	-	-	-	-	-
Leverage	-	-	-	-	-	-	-
Taxes	-	-	-	-	-	-	-
Total	-	-	-	-	-	-	-

Select Additional Articles from Jerry's Corner The Investment Way of Life Four Cornerstones of Success Excuses... More Excuses The Wealth Cycle Investment & the Wealth Cycle An Economics Primer The Life Cycle Creating A Saving Culture Entrepreneurialism A Fortune in Your Hands Look to the Pros - Introduction - Part I - Insurance - Part II - Stock Broker - Part III - Real Estate - Part IV - Attorney - Part V - CPA The Priorities of Life - Introduction - Part I - Health - Part II - Career - Part III - Relationship - Part IV - Home Elements of Investment - Introduction - Part I - Risk - Part II - Management - Part III - Flexibility - Part IV - Liquidity - Part V - Cash Flow - Part VI - Rate of Return - Part VII - Appreciation - Part VIII - Leverage - Part IX - Taxes

Moorman and Company, an accounting and personal financial management firm based in Palo Alto, serves the San Francisco Bay Area, Peninsula, and Silicon Valley from Hillsborough to Saratoga-Los Gatos, including Atherton, Menlo Park, Los Altos, Los Altos Hills, and Cupertino.