How To Eliminate Risk Associated With Growth Funds
In order to achieve long-term growth within your mutual funds portfolio it is believed you will need to incorporate a fairly significant amount of equity or growth funds. While this certainly seems to be a valid argument based on historical rates of return and the difficulty associated with accurate market timing, not all investors need to have a portfolio that consists entirely or primarily of growth mutual funds.
For highly risk averse investors, loading up on growth mutual funds would obviously be imprudent and no financial advisor, tenured or otherwise, would ever recommend doing so. But imprudent would also be ignoring the growth asset class entirely.
Now there is a way for investors to ensure that they eliminate equity risk in their portfolio, even while investing in the wildest, highest of high risk equity funds. They do this by finding a guaranteed investment, whether it is a quality bond, term deposit or other virtually or entirely risk-free investment and working out how much interest they will earn over the time horizon of their investment.
Let’s take a closer look at an investment that pays 5% per year. If you had $10,000 in total to invest and you wanted to make sure that it was guaranteed over ten years, you could actually invest $3,860 in high risk equity mutual funds that could return whatever the market allows. The remaining $6,140 would earn 5%.
But regardless of the performance of those equity funds, the remaining $6,140 invested in that guaranteed or extremely low-risk investment at 5% would be worth $10,000 after ten years. This allows you to invest $10,000 today and enjoy absolutely no risk at all. The catch? That you wait 10 years without touching the $6,140.
The worst-case scenario would see the equity mutual funds worthless after 10 years. The best-case scenario is that the return is greater than 5%, leaving you with more than if you invest $10,000 in its entirety in the guaranteed 5% investment. Realistically, you should expect a higher return. Even a 7.5% return on the equity fund would bump your portfolio’s performance from 5% to a little over 6%.
Might not seem like a lot, but 7.5% over 5 years is really a lower-risk equity fund. And, really, the point is not so much that you are now outperforming your friends, but that you are achieving that performance without any risk at all to your capital.
