When you think about risk, does it bring a sense of excitement, or does it make you uneasy? For many, the concept of risk can be both thrilling and intimidating, depending on the context. Perhaps you embrace risk when skiing down a mountain but shy away from it in your financial investments. Regardless of your comfort level, understanding the risks that can impact your retirement money is crucial. One of the most significant financial risks to consider is risk to principal—the potential for the value of your investments to decrease.
At Wealthy Choices®, I help clients understand these risks and develop strategies to manage them effectively, ensuring their retirement goals remain secure. Let’s dive into what risk to principal means and how you can mitigate its impact.
What Is Risk to Principal?
Risk to principal refers to the possibility of losing some or all of the money you initially invested. This can occur with investments like stocks, bonds, ETFs, and even real estate. For example:
- Suppose you purchase an investment at $30 per share. Over time, its value drops to $15 per share. On paper, you’ve experienced a loss, but it’s not a realized loss unless you sell at that lower price.
- However, if you must sell the investment—for instance, to cover a large expense like medical bills—you would lock in that loss and reduce your principal.
This type of risk can feel particularly acute when market values fluctuate daily or even minute by minute. It’s easy to feel uneasy when you see these shifts, even if they don’t immediately affect your financial situation.
Why Houses Aren’t Immune to Risk to Principal
It’s common to think of real estate, particularly your home, as a stable and safe investment. Unlike stocks, you don’t see daily updates on your home’s value. But home values also fluctuate, often based on broader economic trends.
For instance, during the Great Recession (2007–2009), many homeowners saw the value of their properties decline significantly. According to the S&P/Case-Shiller U.S. National Home Price Index, home prices dropped by 12.75% during this period.
If you needed to sell your home in that environment, you might have faced a significant loss. A house valued at $300,000 before the recession might have sold for $261,750—a loss of $38,000 in market value. This highlights that, like stocks, your home can lose value, especially if you’re forced to sell during a downturn.
How to Mitigate Risk to Principal
Managing risk to principal involves thoughtful planning and aligning your investments with your financial goals and timelines. Here are some strategies to consider:
- Match Investments to Your Time Horizon
- Investments are less risky when you can hold onto them through market fluctuations. If you won’t need the money for 10 years, you may feel less pressure during short-term downturns. Conversely, if you may need access to funds within six months, opt for more stable and liquid investments.
- Diversify Your Portfolio
- Avoid putting all your eggs in one basket. Diversification across asset classes—stocks, bonds, real estate, and cash equivalents—can help reduce the impact of a downturn in any single market.
- Assess Your Cash Needs
- Before investing, consider how quickly you might need access to your money. Investments with higher volatility may not be suitable if you anticipate needing cash in the near term.
- Don’t Panic in a Downturn
- It’s natural to feel anxious when markets dip. However, selling during a downturn often locks in losses. If possible, give your investments time to recover, especially if you’ve selected quality assets.
How I Help My Clients Navigate Risk
At Wealthy Choices®, I work closely with clients to assess their risk tolerance, financial goals, and timelines. Together, we develop a personalized strategy that balances potential returns with appropriate risk levels. Whether it’s understanding how to ride out market volatility or deciding on the right time to sell a home, my goal is to empower you to make informed, confident decisions about your financial future.
Ready to Preserve Your Principal?
If you’re concerned about risk to principal and how it could impact your retirement plans, let’s talk. I can help you evaluate your investments, match them to your goals, and ensure your portfolio is prepared for the ups and downs of the market. Contact me at 781-577-2311 or visit WealthyChoices.com to start building a more secure financial future.