Before making a decision on what to invest in and what to avoid, a common investor needs to know that he or she has to do to find the optimum balance between risk and return. A lot of investors tend to take more risk for hope of a greater return, jeopardizing their capital. On the other side the extremely risk averse investors look for risk free investments only, eliminating the prospect of earning a greater return. The common investor also requires knowledge of the different types of investments he or she can make.
Formulating the optimum portfolio is all about choosing the right investments and appropriating the right proportion to each type of investment. So it is all about choosing the right investment mix to have the best investment portfolio. The different types of investments one can generally make are stocks, bonds and money market securities. These three types of investments make up the portfolio of any average investor.
A common investor cannot comprehend the reasons of fluctuations in stocks. Though investing in individual stocks and bonds has its appeal, it is not the preferred way to go for the average investor as he or she may not be able to pick the right stock in most cases. Therefore the safer way to go is to invest in stock funds. The same goes for bonds and money market securities and here you have the bond funds and the money market funds.
When you invest in stock funds instead of individual stocks, it means that you are dealing with money managers who pick the stocks and bonds for you to purchase along with a host of other investors. These professionals of course have a better idea of what to buy and what to leave. This results in greater returns on your investment.
The return on bond funds depends upon interest rates. Higher rates of interest will yield lower return on bonds and higher returns on money market securities. It is advisable not to make long term investments in bond funds due to the fluctuating nature the rate of return. Money market securities are the safest form of investment as they are completely risk free.
After settling the modes of investment, the investor needs to make the most important decision. That is, the investment mix which gives the maximum return or formulation of the best investment portfolio. Here we need to recall that stocks carry the greatest risk, followed by bonds while money market securities carry negligible risk.
Being to risk averse and putting the greatest proportion of your investment in the money market will yield the lowest return though it is the safest way to go. At the same time you should not be taking too many risks for a greater return. Applying the principle of diversification is the key to the best investment portfolio.
Summarily, to cut down on the risk of stocks, invest in a number of them. Do not forget to make investments in short term bonds and always put some amount in money market securities. Divide your investments across and within these three different types of investments.