Do you understand the risks involved in investing?

More importantly, they do not completely understand the associated risks. 

Certainly, the potential for reward tends to outweigh the downside of the investment.

But risk and reward are two key components in understanding the type of investment you should be looking at.

Risk, in general, is defined as the possibility of sustaining a temporary or permanent loss.

This is true in the world of investments.

Investments termed ‘high risk’ have a significant possibility of experiencing large swings in their returns.

In the simplest of terms, risk is a measure of whether a surprise will occur — both positive and negative.

For example, a company’s revenue and profits may explode suddenly and the stock price rapidly moves upward, a positive surprise for stockholders.

Sometimes a company’s results are poor and the stock price will tumble, a negative surprise for stockholders.

Tolerance

Individuals will have very different tolerances for risk and their tolerance will change during their lifetimes.

In general, if an investor needs cash within a short period of time, then he or she should not put money into high-risk vehicles. But if an investor has a very long-term horizon, they should consider choosing investments that offer the best possibility of good returns.

The long period of time before that person needs the money offers the investment a chance to grow and occasional downturns will most likely be offset by other gains.

Many investors understand the principles of diversification and risk well enough to know it is unwise to put all of their eggs in one basket.

But many do not always know how to avoid this in practice. Most successful investors will tell you that diversification is key.

A diversified investment portfolio not only reduces unwanted risk but also contributes to a potentially more profitable portfolio.

Having a well-diversified portfolio does not necessarily mean buying a second investment — it means branching out into other asset classes.

Portfolio

Always do your homework and never invest in anything you do not understand. The more you know, the better off you will be.

You work hard for the money you make, so it is equally important to work hard to understand how to make the most out of your investments.

Understand how each of your investments fit with the rest of your portfolio and with your overall strategy.

Finally, it is imperative that you read the fine print. Make sure you understand the restrictions and fees associated with your investments.

Is there a minimum level at which you can invest? Is there a cost to get into the fund (front-end load) or get out of the fund (back-end load)?

Is there a minimum commitment time or locked in period? What is the penalty for making withdrawals? How is the investment advisor compensated? Is the advisor paid a salary or commission or a combination of both?

There is no golden rule to investing or right or wrong answers.

The key questions that you must always ask yourself are: Do I understand what I am investing in? Do I understand the associated risks?