One of the most often repeated ‘rules for successful investing’ is this:  Risk and return go hand-in-hand.  Low return investments equal low risk.  Higher return investments equal higher risk.  In this extended period of low interest rates for so-called ‘safe’ investments, you may be wondering how much stock to put into this rule.  After all, better investment returns now mean stronger portfolio growth over the long term and, ultimately, a more comfortable retirement at a time of your choosing.

So, should you be seeking out ‘riskier’ investments to beef up your returns?  Well, rules are rules for a reason – because they tend to work in the ‘big picture’ – but the answer can be a ‘yes’, when you make the right choices among ‘riskier’ investments for the right reasons.

What is your risk tolerance?

The first thing you must do is establish your tolerance for risk.  Every investment you make does involve a tradeoff between risk and rewards.  What kind of investor are you?  Conservative investors usually stick with bonds, Guaranteed Investment Certificates (GICs) and money market funds.  Moderate investors will take more risks and invest in growth stocks, mutual funds and bonds.  And aggressive investors aren’t afraid to put their money in volatile investments that can experience wide swings in value. 

Most investors are a combination of these three ‘types.’  The test for your personal risk tolerance level is simple:  Do your investment choices allow you to sleep at night?  If not, you’re investing outside your comfort zone and it’s time to rethink your investment strategy.

What is your expectation for returns?

Once you’ve figured out your risk tolerance level, you’ll want to establish the level of returns you need to reach your financial and life goals.  And here’s where that ‘risk/reward’ rule really comes into play:  riskier investments do, indeed, have the potential to deliver much better returns than ‘conservative’ investments – and you may need those higher returns to reach your goals.

Yes, you can manage risk

The good news is, there are ways to maximize the potential for higher returns in your investment portfolio and manage risk at the same time.  Here are four ‘risk management’ techniques that can work for you.

1.  Stay the course. Markets fluctuate and the price of any stock or equities mutual fund is bound to be somewhat volatile in the short term.  But time can take away much of that risk.  Study after study has proved that time in the market delivers much better returns than trying to time the market.  Remember – you’re looking for long-term growth, so don’t change your investment mix with every move in the markets.

2.  Diversify. Spread out the risk by diversifying your portfolio.  There are three major asset groups: Cash, Fixed-income investments, and equity investments.  To reduce risk, your portfolio should include investments from all three groups.

3.  Use dollar-cost averaging.  This technique involves buying equal dollar amounts of a given investment on a regular basis – say, $100 every month.  It works well for investments that fluctuate, such mutual funds that invest in stocks. By buying a fixed dollar amount every month, you buy more units when the price is low, and fewer when the price is high.  Your overall cost is lower, your potential for returns is higher, and you don’t have to worry about market timing.

4.  Asset allocation works. This technique simply means assembling the right mix of investments, selected from the different asset groups, that best suit your goals and risk tolerance.  It works because different types of securities do well or poorly at different periods in an economic cycle but over time, each will take a turn delivering above average returns.  By having the right mix of holdings in your portfolio, you’ll be in a position to maximize your long-term overall return, while maintaining the level of risk you’re comfortable with.

You shouldn’t worry unduly about risk.  The key is to understand the risks and, with the help of a professional advisor, build a portfolio that has the right level of risk and the right risk management strategies for your personal situation.