When you invest, more risk means more potential reward, and vice versa.
This doesn’t mean you should throw caution to the wind for the sake of a potential profit. It does mean that you should try to strike a balance between risk and reward in your investments, and a great way to do that is to diversify your portfolio.
But what does a diversified portfolio look like? For starters, it holds investments that represent all three major asset types: cash, bonds, and stocks. Let’s talk about each asset class and what it means in terms of risk.
First, there’s cash. Cash held in savings accounts and money market funds is considered the lowest-risk investment.
You probably won’t lose money when you invest in cash, but you won’t gain much either. The main risk you take on is purchasing power risk—meaning your money may not grow enough to keep pace with inflation.
Next on the risk spectrum are bonds.
With bonds, you stand to gain a moderate return in exchange for a moderate amount of risk. Bonds can act as a stabilizer to offset the price fluctuations of stock investments.
Finally, stocks are considered the highest-risk investments.
Of all three asset classes, stocks are the most volatile, meaning their value is most likely to fluctuate. This means more market risk.
We think the strongest portfolios contain investments that give you exposure to all three kinds of assets. You want to take on enough risk to give your money a chance to grow, but not so much that a dip in the market would mean oversized losses.
You can learn more about diversifying your portfolio to control risk at vanguard.com/LearnAboutRisk.