Many people come up with unrealistic answers to the question of how much risk is right for them. For instance, when they’re young and just starting out, many investors decide to move away from safe investing principles and speculate. They expect to build a small portfolio into a big one in a hurry, then shift their money into boring, but more dependable investments.

Heavy losses can be especially damaging for young investors

As a newcomer in any field, however, it’s easy to fall victim to ruses and snares that someone with more experience would spot right away. Later on, you’ll know better than to bid on an ugly painting just because it’s the work of a noted artist, or invest in a building that faces expensive repairs due to delayed maintenance, or buy a promotional stock due to rumours or touting.

Note that when a young person loses money, the loss is doubly costly. You have the obvious immediate loss. You also miss out on decades of compounding that you could have profited from in a better-quality investment.

Safe investing: Holding fixed-return investments also entails risk

Later in life, some investors make the opposite mistake. They decide in retirement that they are too old to assume any investment risk, and that they should put most, if not all, of their money in safe investing picks, specifically fixed-return investments and government bonds. They work out a budget that shows they can live with today’s under-4% bond yields.

It’s true that government bonds don’t expose you to any default risk. But it’s equally true that they are not always the best safe investing choice. Today, they are a particularly poor choice, because they leave you at the mercy of inflation and rising interest rates.

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Right now, the risk of a significant rise in inflation and interest rates may seem small. But both remain at the low end of their historical ranges. So the next big move, though it may still be years in the future, is likely to be upward. Meanwhile, taxes weigh particularly heavily on any interest income.

A two-point cut in your rate of investment return, and a loss of the tax deferral available in stocks, can take an enormous bite out of your capital over a decade or two.

In between the extremes of youth and old age, many investors repeatedly make the mistake of getting more bullish or optimistic as stock prices rise. This is the opposite of a sound, safe investing strategy. It can leave you owning the riskiest portfolio of your life just when it can do maximum harm to your finances.

Well-established companies are the key to profitable and safe investing

Instead of moving between extremes of risk, we continue to think investors will profit most — and with the least risk — by buying shares of well-established companies with strong business prospects and strong positions in healthy industries.

That’s not to say that there won’t be surprises that affect every company in a particular industry. But well-established, safety-conscious stocks have the asset size and the financial clout — including solid balance sheets and strong cash flow — to weather market downturns or changing industry conditions.
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