More Straight Talk on Investing

11Risk: Give It the Gut Test

I've been talking a lot so far about the long-term rewards that you can reap as an investor if you are willing to accept a prudent and comfortable level of risk. Investing in money market funds instead of keeping your money in the bank is one example of taking a prudent risk that carries worthwhile rewards—the rewards being relatively higher income on your cash investments. In this case, the risk is minimal. But another example of prudence is choosing to invest your long-term retirement assets in a well-diversified stock fund instead of keeping them entirely in a money market fund. Though the stock market is definitely risky, most long-term investors find that the potential rewards are well worth the risk, as long as they take care to diversify and have the fortitude to ride out periods of volatility. In both of these investment scenarios, risk is an ally in your effort to increase your wealth.

Risk can be both friend and foe, so prudent investors pay careful attention to it when they construct a portfolio. In this chapter, I'll focus on two aspects of managing risk:

• How to understand the level of risk in your overall portfolio and to avoid worrying over the risks of specific holdings. The reason for taking a holistic view is that the risk factors of some holdings can be mitigated by those of other holdings. For example, the price stability and income of money market funds serve to offset some of the volatility of stock prices.
• How to assess whether ...