Which Investments Are The Most Risky?

One of the bedrock principles of investing is that there is a direct link between risk and return. To get higher returns, you must accept more risk. Take a look at this risk pyramid from National Endowment for Financial Education (NEFE).

*Investments at the top of the pyramid tend to be non-liquid and speculative in nature.
*Investments at the top of the pyramid offer a greater potential reward through capital appreciation, but    also have a greater potential for the loss of principal.
*Investments at the bottom of the pyramid tend to be liquid (easily converted to cash with little principal
fluctuation) and offer a stable, but lower rate of return. While investment products at the bottom of the pyramid pose little risk of loss of principal, there is little or no potential for capital appreciation. Because of this, if the rate of return is less than the rate of inflation, there is a risk that purchasing power may be lost over time.
*Investments in the middle of the pyramid offer a combination of moderate risk and return.

[Source: Smartaboutmoney.org]

Here’s a broader list of asset categories you can invest in (asset classes).  I’ve listed them in order of relative riskiness.  The least risky asset classes are on top, and as you read down the list, they get increasingly risky.  Theoretically, you should earn progressively higher rates of return as you move down the list.  Of course, you should only take as much risk as you NEED to take.  So don’t just jump to the bottom of the list and invest all your money, expecting to make a killing.  You could lose your shirt doing that.

• Cash stuffed under your mattress
• Money Market Fund – FDIC insured
• Savings Account – FDIC insured
• Certificate of Deposit
• U.S. Treasury Bills
• U.S. Treasury Bonds
• Corporate Bonds
• Foreign Bonds
• Large Cap Stocks
• Mid Cap Stocks
• Small Cap Stocks
• Foreign Stocks – Developed Markets
• Foreign Stocks – Emerging Markets
• Options
• Futures
• Penny Stocks
• Lottery Tickets

A good portfolio is a balanced and diversified portfolio.  That means you should first figure out how much return you need, and then choose the combination of asset classes that will generate that rate of return.  At the bare minimum, most investors should have 3 asset classes: Stocks, Bonds, and Cash.  As you gain experience and skill, other non-traditional asset classes can be added, such as

• Gold, Silver, Platinum, etc.
• Commodities
• REITs
• MLPs
• Private Equity
• Hedge Funds
• Volatility