Managing Risk in Your Retirement Plan Account

When it comes to investing, there are various types of risk. While most investors tend to think of market risk—the possibility that an investment will decline in value—whenever they hear the word “risk,” there are actually several kinds of risk that retirement savers face, and they are virtually unavoidable. But understanding the various kinds of risk is extremely important, since it can help you make educated investment choices for your retirement account.

Various Types of Risk
  • Inflation Risk—The possibility that the growth of an investment may not keep pace with the average rate of inflation. In this sense, seemingly "safe" investments that do not outpace inflation  may be the riskiest over time. So, for example, if your investment is earning 2.5% each year, but inflation is averaging 3% annually, you’re likely losing money.
  • Market Risk—The possibility of losing money due to the decline in the price of an investment. Stock investments are most commonly associated with market risk.
  • Interest Rate Risk—The possibility that an investment will decline in value with a rise in interest rates. An older bond, for example, paying a lower rate of interest becomes less valuable than a newer one that pays a higher rate. Higher interest rates also tend to reduce stock prices, because they increase the cost of borrowing for companies.
  • Longevity Risk—The possibility that investors will outlive their retirement income.
  • Business Risk—The possibility that a particular company or industry won’t perform as expected. Both stocks and bonds carry this risk.
  • Currency Risk—Changes in the exchange rate between currencies can affect the value of foreign investments, for better or worse. Note that this type of risk can also affect investments held by a U.S. company issuing stocks or bonds, changing the value of those investments, too.
Balancing Risk and Reward

Generally, the more risk you take, the higher the potential rewards. However, most successful investors don’t always take the highest risk—nor do they try to avoid it. Avoiding risk altogether can be a risk itself. Money that is not invested will likely lose value due to inflation. So potentially making money through investments requires you to consider the various kinds of risk, and find a balance among a range of investments to manage that risk.

The Importance of Time

To a degree, risk tolerance is a function of time. Investors who have more time to let their investments grow may be in a better position to use higher-risk/higher-yield investments than someone who needs their money right away. So you may wish to carefully consider—and reconsider—both your feelings about risk and your investment time horizon when choosing investments for your retirement account.

Managing Risk

Asset allocation and diversification are important strategies to consider when choosing investments:
  • Asset allocation is the process of investing your money in various types of investment asset classes (such as stocks, bonds, and stable value investments), thereby spreading out your investment risk.
  • Diversification takes asset allocation one step further by investing in a variety of investments within those asset classes. Since different investments generally react differently to varying market conditions, asset allocation and diversification work in tandem to help manage  the risk you might face if you held only one type of investment in one asset class.

Please keep in mind, application of asset allocation and diversification concepts does not ensure a profit or protect against loss in a declining market. It is possible to lose money by investing in securities.

For more information, refer to Choosing Your Retirement Plan Investments.

To Learn More…

You can learn more about risk by contacting a financial professional or a Prudential® Retirement Counselor.* Simply call 1-877-PRU-2100 toll free, Monday through Friday, from 8 a.m. to 6 p.m., ET and say "Retirement Counselor."

* Retirement Counselors are registered representatives of Prudential Investment Management Services, LLC (PIMS).

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