The key to choosing investments is to understand that: the higher the risk, the higher potential return. However, riskier investments also have a higher potential loss.

What is Your Risk Tolerance?

So, before investing, you first need to determine what your risk tolerance is. Your risk tolerance is how much risk you are willing to live with in order to have a chance at a possible return. Your risk tolerance can be determined by a number of different factors:

• How long are you going to invest? (Longer time = higher risk)
• How much money can you afford to lose? (Higher amounts = higher risk)
• What are your financial goals? Specifically, how much money do you want to accumulate in a certain period of time? (The higher return required = higher risk).
• What is your personal preference (i.e., Are you content to wait, hoping that an investment that drops in value will rise again?) (More patience = higher risk)
• Where is your personal comfort level? (If you are willing to "live on the edge" = higher risk).

Types of Investments

There are literally thousands of things you can invest money in. This is not a comprehensive list; however, this is a list of a few major types of investments, along with a brief explanation of their risk levels.

• Savings account. A typical savings account at a bank is a very low risk investment, but also has very low returns. These accounts are typically FDIC insured up to $100,000 (meaning that the government insures your investment up to $100,000)
• Money Market Funds. These accounts are not FDIC insured, but typically will earn you a higher return. The bank invests this money in very low risk investments and in exchange, the bank pays you a small return, currently around 3 to 5%.
• Certificate of Deposit (CD's). The more you invest and the longer the term, the higher the return. The downside to CDs is that you are penalized if you pull your money out early.
• Bonds. A bond is essentially a loan to someone else, usually a municipality. A bond will pay a "coupon payment", typically every six months (payments to the investor for loaning his or her money). The coupon payment gives an average return on the investment of around 6%. At the end of the bond term, if held to maturity, the investor will receive the principle investment in return (in addition to the coupon payments).
• Stocks. A share of stock in a company is a portion of ownership in the company. Therefore, if you purchase a share of stock in McDonald's, you actually own a small portion of McDonald's. Stocks are considered more risky than bonds and are not FDIC insured. The riskiness of a stock is determined by the company that you have invested in. Therefore the return can vary greatly. You could lose all of your money in a stock, or you could receive a 10,000% return on your investment. The average S&P 500 (the largest 500 stocks) return over the past 30 years is around 12%.
• Real Estate. Investing in your own home is certainly important; however, investing in real estate overall can be a very wise venture. Real estate investing may include rental properties, land, development, "flipping" homes, commercial properties, and many other options. The average annual return on a residential home in the US over the past 30 years is anywhere from 1% to 7%.

So, first determine your risk tolerance, and then choose an investment type that you are comfortable with. If you are not comfortable "living on the edge," don't do it! There are many other types of investments; however, these basic few can certainly help an individual achieve his or her financial goals.