Nearly 1 in 4 Americans Believe Risk-Taking Builds Wealth. Is It the Key to Financial Success?

Risk is a key part of building wealth, and higher returns come with a higher chance of loss. According to a survey by financial services company Empower, 23% of Americans said risk is important if you want to accumulate wealth.

But that doesn’t mean you should take risks carelessly. Experts say that taking calculated risks and balancing your investments can help preserve your assets while seeking higher returns.

What Is Risk?

Risk is inevitable in any type of investment. As an investor, you’ll come across many different types of risks. Some of the most common include:

• Business risk: These are internal or external risks that could negatively impact a company’s profits, including the economy, natural disasters, or operational inefficiencies.
• Currency risk: Fluctuating currency rates can affect the value of your investments.
• Inflation risk: The risk that rising prices will reduce the returns of your investments over time.
• Interest rate risk: Your investments may see a loss when interest rates change.
• Liquidity risk: This is the risk you run when you can’t sell your investment quickly when you need cash.
• Market risk: Market risk refers to any losses in your investment as a result of changes in the overall market.
• Political risk: Your investment returns can be affected by any decisions made by governments, such as taxes and policy changes.

But do Americans truly understand the concept of risk? Most investors do, according to Todd Calamita, founder of Calamita Wealth Management, who says it’s about taking calculated risks rather than impulsive ones.

“Risk isn’t just about temporary market drops. It also includes outliving assets, inflation eroding purchasing power, and sequence of return risk (particularly in retirement),” he says. “Most people benefit from education about the types and consequences of various risks to make more informed decisions.”

The Risk-Reward Tradeoff

Most investors know that to earn a higher return, they have to take on more risk. This is known as the risk-reward tradeoff. How much risk you take depends on several factors, including your goals:

• Low-risk goals like a rainy day or vacation fund are considered short-term, so you’re likely going to put your money in a savings account.
• Buying a home or saving for retirement, on the other hand, are long-term goals and can withstand riskier investment options.

Your age also influences the amount of risk you take with your investment decisions.

“Younger investors with longer time horizons have a higher capacity for risk, whether they have a higher risk tolerance or not. Whereas older investors with shorter time horizons tend to have a lower risk capacity regardless of their tolerance,” Easton Price, a financial planner with Prosperity Wealth Planning, told Investopedia.

Price added that some older investors may have enough assets to support themselves for the remainder of their lives and can maintain what he called a “riskier investment allocation” because they’re investing their money for their heirs.

Managing Risk and Accumulating Wealth

Every investment vehicle carries some degree of risk, whether it’s a bond or a stock. While you can’t avoid financial risk in your portfolio, there are ways you can manage and mitigate it to boost the potential for your returns. The best way to do so is to identify your goals, understand how risk and reward work, and understand your risk tolerance.

Experts suggest diversifying your holdings across a spectrum of low- to high-risk assets based on these factors. According to Calamita, your portfolio could look something like this.

• Low risk: High-yield savings, CDs, Treasury bonds, money market funds. The reward here is capital preservation and liquidity, but with limited long-term growth.
• Medium risk: A diversified mix of stocks and bonds and/or balanced mutual funds. Certain annuities would fall into this category as well. This type of mix balances growth potential and stability.
  
• High risk: Concentrated positions in individual stocks, emerging markets, or speculative assets like cryptocurrencies. While these might offer outsized gains, they also come with significant downside and volatility. 

Price adds that younger investors typically have an all-stock allocation because they have a higher risk tolerance and a longer investment time horizon. This gives them more time to recover when there’s market volatility. Older investors tend to have a blend of all of the above, with greater allocations dedicated to cash and bonds.

Financial experts also suggest that you revisit and adjust your portfolio as your situation changes to make sure it aligns with your short- and long-term goals. Your willingness to take on risk will change as you get older and your time horizon to retirement gets shorter.

The Bottom Line

Risk may bring up negative images, but it isn’t inherently a bad thing in finance. Taking some risks is essential if you want your money to grow.

You just have to know how to manage it and understand how to make it work for you. The best thing to do is to work with a financial professional who can identify your goals so you can mitigate your losses and wade through all the noise.