Seeking an iron-clad way to manage risk? Keep looking. Rule number one of investing: If you can't handle the heat then get out of the kitchen. If you are risk aversive then your best bet is investing your money in government treasury bonds which offer a fixed rate of return. The stock market is volatile and risky by nature which is the very reason it generates greater returns than government bonds or bills. Investing in stocks can put your entire principle at risk and there are no guarantees - only the potential for profit.
On the other hand, in an attempt to manage risk, many people overlook one of the biggest potential threats to their investments: Inflation. Your principle may be safe when invested in savings bonds or Treasury bills but inflation slowly erodes the purchasing power of your investment. While your balance sheet shows growth, the reality is you have little more than you started with. Remember, the government inflation index doesn't account for many areas of day-to-day inflation that impacts your life such as groceries or insurance so your true purchasing power is decimated by a low rate of return. For example, yearly rates of return of Government bonds is 3 percent vs. the Stock market's 8 percent. To put it in perspective, compare these 1970's prices to what you pay for the same items today:
1970 Prices
- One Dozen Eggs: .59 cents
- 10 lb Bag Potatoes: .99 cents
- Loaf Bread: .37 cents
- New Car: $3,710
- House: $23,450
- Gasoline: .35 cents
To truly manage risk, compare the risk to the potential reward and then establish guidelines for investing that meet your need for growth versus safety.