Nearly 1 in 4 Americans believe that risk builds wealth. Is it the key to financial success?

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

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

What is the risk?

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

• Business risks: These are internal or external risks that can negatively impact a company’s profits, including the economy, natural disasters, or operational inefficiency.
• Currency risk: Volatile currency rates can affect the value of your investments.
• Inflation risk: The risk that rising prices will reduce the returns on your investments over time.
• Interest rate risk: Your investments may experience a loss when interest rates change.
• Liquidity risk: This is the risk you take when you cannot 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 risks: Your investment returns can be affected by any decisions made by governments, such as taxes and policy changes.

But do Americans really 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 reckless ones.

“Risks are not just limited to temporary market declines,” he says. “They also include assets that expire, the erosion of purchasing power due to inflation, and sequence of return risks (particularly in retirement).” “Most people benefit from education about the types and consequences of different risks to make more informed decisions.”

The trade-off between risk and reward

Most investors know that to get a higher return, they have to take more risk. This is known as a risk-reward trade-off. The amount of risk you take depends on several factors, including your goals:

• Low-risk goals like a rainy day or a short-term vacation fund are considered low-risk, so you should probably put your money in a savings account.
• On the other hand, buying a home or saving for retirement are long-term goals and can afford riskier investment options.

Your age also affects the amount of risk you take in your investment decisions.

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

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

Risk management and wealth accumulation

Every investment instrument carries a certain degree of risk, whether it is bonds or stocks. Although you cannot avoid financial risks in your investment portfolio, there are ways you can manage and mitigate them to enhance your return potential. The best way to do this is to define your goals, understand how risk and reward work, and understand your risk tolerance.

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

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

Price adds that younger investors typically have an allocation to all stocks because they have a higher risk tolerance and a longer investment time horizon. This gives them more time to recover when there are market fluctuations. Older investors tend to have a mix of all of the above, with a greater allocation to cash and bonds.

Financial experts also suggest revisiting and adjusting your investment portfolio as your situation changes to ensure it aligns with your short- and long-term goals. Your willingness to take risks will change as you get older and your retirement time horizon becomes shorter.

Bottom line

Risk may evoke negative images, but it’s not an inherently bad thing in finance. Taking some risk 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 you can do is work with a financial professional who can define your goals so you can mitigate your losses and cut through all the noise.