Risk vs Reward

In this article, we’ll define four of the most common investment vehicles: stocks, bonds, mutual funds, and ETFs (Exchange-Traded Funds). We'll look at how each one works, the potential rewards they offer, and most importantly the risks you may take on by including them in your investment portfolio. Knowing these differences can play a big role in building a portfolio that matches your goals, time horizon, and risk tolerance.

Stocks:

 Ownership shares in a company. When you buy a stock, you own a piece of that company.

While stocks are known for having higher long-term returns and more liquidity than other investment vehicles, they can tend to be riskier because they are prone to market volatility. There’s also potential for company specific risk (bad earnings, scandals, etc.). Diversifying across sectors or industries can help to mitigate some of that risk.

Bonds:

 A loan made by an investor to a borrower (typically a government or corporation) in exchange for interest payments.

Bonds are generally lower risk than stocks although they’re vulnerable to interest rate changes and inflation. “Laddering” bond investments, that is creating a portfolio of bonds with staggering maturity dates, is a strategy many investors use to attempt to manage interest rate risk. Another risk to the investor, is credit risk if the issuer defaults, meaning the borrower (the municipality or corporation) can’t pay the investor what they owe them. This is why it’s important to invest in high quality bonds.

Mutual Funds:

A pooled investment fund managed by professionals, consisting of a mix of assets like stocks and/or bonds.

The risk level of a mutual fund usually depends on the fund’s holdings. Since mutual funds are typically comprised of a wide range of assets, the diversification they bring can help to reduce risk that would have come with investing only in individual securities. When choosing mutual funds, it’s important to choose funds aligned with your risk tolerance.

ETFs (Exchange-Traded Funds):

A basket of securities (like a mutual fund) that trade on an exchange (like a stock)

Some ETFs track broad indexes, while others target specific sectors or themes. This allows them to offer diversification which can spread the risk and help mitigate the impact of poor performance from any one security. Keep in mind, regardless of what they track, all ETFs are still subject to market risk, so when deciding on ETF investments it can be helpful to understand the fund's objective.

There’s no one-size-fits-all approach to investing. Managing risk isn’t about avoiding it altogether, it’s about making sure your investments align with your personal goals, time horizon, and comfort level. The more you understand how each asset class behaves, the better equipped you'll be to build a portfolio that grows over time while weathering the inevitable ups and downs of the market.