Saving and investing are important to ensure you have the cash you need to meet your financial goals and enjoy a comfortable retirement, but every financial decision carries risks. Making wise financial decisions requires being aware of the risks involved and how they are likely to affect you. Risks will vary depending on the circumstances, but there are several common risks that are likely to affect you in many financial situations.
Prices in the marketplace tend to increase, or inflate, over time. Inflation causes the value of money to fall. If the average cost of goods goes up 5 percent, each dollar you have buys 5 percent less. As a result, inflation reduces the effective returns you get from saving and investing. For instance, if a savings account pays 3 percent interest, but the inflation rate is 2 percent, your effective return is only 1 percent. Conservative investments with low returns run the risk of failing to beat inflation, which can cause the value of your savings to fall over time.
The value of property can change over time based on consumer demand. For example, if you buy a home, its value could go up if many people want to move to your neighborhood. On the other hand, the value of a home can go down if few people are interested in buying. Many economic factors can influence consumer demand, such as changes in interest rates, unemployment, lending practices and the growth rate of the economy. The possibility of property losing value due to changes in market demand is known as market risk and is a major concern when investing in things such as stocks and real estate.
The Internal Revenue Service makes you pay taxes on a wide range of income sources, including cash you make from savings and investments. Taxes on investment profits are higher if you sell an investment within a year after buying it, so trading investments frequently can increase your taxes. Putting cash in tax-advantaged retirement plans such as a 401(k) or individual retirement account can help cut your taxes and increase the chances of making money.
Fees and Expenses
Some investments come with expenses and fees that serve to reduce your total return. For instance, you typically have to pay a transaction fee each time you buy or sell a stock, and financial companies may charge a fee for keeping an account open. Fees and expenses eat into investment returns over time and increase the risk of losing money. For example, if you invest in a mutual fund that generates a 4 percent annual return, but the inflation rate is 3 percent and the fund charges a 2 percent annual fee, the real value of your investment would actually fall by 1 percent due to the combined effects of inflation and fees.
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