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In investment terms, risk means simply the chance that your investments will lose money. All investments involve some degree of risk. As market conditions change, the value of your investment could decline and you could potentially lose money. However, there is a trade-off between risk and return. In general, the more risk you are willing to take in the short term, the higher the potential for favorable returns over the long term. Investments like stock funds are considered higher risk, but offer the potential for higher returns over the long-term. Their value can fluctuate sharply over a week, a month or a year, but over very long periods, they have historically earned higher returns than any other asset class.1 Past Performance is not a guarantee of future results.
While there are many types of risks, here are four of the most important ones that can affect mutual fund investments.
- Management risk: This is the risk that your portfolio manager will pick the wrong securities and that the fund will perform worse than other funds in the same category. Although past performance is not a guarantee of future results, you can attempt to deal with this risk to some extent by selecting managers with good long-term track records.
- Inflation risk: This is the risk that the value of your investments will not grow as fast as the rate of inflation. For example, say you invest $100 and earn a one-year return of 2%. In the same year, the price of groceries rises 5%. If you withdraw your money to buy groceries, you will have only $102 to buy goods whose price has risen to $105. Even though you have more money in nominal terms, it's worth less.
- Market risk: This is the risk that the broad market will decline in value, exerting downward pressure on the performance of individual securities and mutual funds that invest in that particular market.
- Interest rate risk: This risk primarily affects bond funds, since the value of securities in a bond fund portfolio moves in the opposite direction of interest rates. When interest rates go up, bond prices go down and vice versa. Interest rates also have an effect on certain types of stocks - like bank stocks and utilities. You can attempt to protect against this risk by including a broad mix of asset classes, such as stocks, bonds and cash, in your portfolio.
Fund Specific Risks
It is important to carefully consider each fund’s investment objectives, risks, fees and expenses before investing. All funds involve some risk, including possible loss of the principal amount invested. There are some additional risks to consider when investing in certain funds within RS family of mutual funds:
- Small-cap investing entails special risks, as small-cap stocks have tended to be more volatile and to drop more in down markets than large-cap stocks. This may happen because small companies may be limited in terms of product lines, financial resources and management.
- International investing has special risks related to changes in currency rates, foreign taxation, differences in auditing and other financial standards, political uncertainty and greater volatility. These risks are even greater when investing in emerging markets.
- Investing in bond funds exposes you to the general risk of investing in the debt markets. Bond funds are subject to interest rate risk.When interest rates rise, bond prices generally fall, and when interest rates fall, bond prices generally rise. Currently, interest rates are at historically low levels. Please keep in mind that in this kind of environment, the risk that bond prices may fall when interest rates rise is potentially greater.
- Investing in high-yield bonds involves special risks because investments in lower rated and unrated debt securities are subject to greater loss of principal and interest than higher rated securities.
- Low duration bond funds are not an alternative to money market funds since they, unlike money market funds, do not seek to maintain a stable net asset value and, as a result, are a riskier asset class.
Generally you can manage risk better by understanding the types of risks associated with your investments, knowing your personal risk tolerance and learning how to implement investment strategies that may help to minimize risk, such as dollar cost averaging, diversification and asset allocation.
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