Unraveling the Essentials of Investing

Written by Jordan Waldrep, CFA , Bank OZK Chief Investment Officer

When we look at how an Investment Manager builds a portfolio for their client, there are essentially three different categories of investment that can be represented.?

1. Cash is good old fashioned hard currency. Keep it in your checking account or put it into a savings account.?
2. Debt is a loan, often called a bond. If you buy a bond, you are loaning your cash to the bond issuer at some rate of interest, and you believe it will be paid back in the future.
3. Equity is ownership, often called stock. It is a stake in the company that issued it. For example, if you purchase one share of a company’s stock, you are buying equity in that company. You now own a small percentage of the company.?

With a few notable and risky exceptions, almost every investment you would consider falls under one of these three broad categories.

Risk

This leads us to an important concept in investing called risk. Risk in investing is a measure of the variability or likelihood of realizing the returns you expect. The three categories listed above are fundamentally different because they carry different levels of risk.

• Cash is very low risk. If you have $1,000 in your checking account, you can get that cash at any time to spend on whatever you would like.
• Debt has more risk. If you buy $1,000 in a company bond, they will probably pay you back, but there is a chance that the company could go bankrupt and cannot pay your loan back. More importantly, if you buy a bond, you cannot spend that cash today. You must wait for the bond to mature before you get your cash back.
• Equity is the highest risk on this list. If you buy $1,000 in a company’s equity, you are hoping that the company will become more valuable. The value can change significantly every day, and the only way you can get your money back is to sell that equity to an interested buyer.

The risk level in each of these categories increases as you go down the list. For an investor to take more risk (i.e., there is a greater chance that they lose their investment), the investor must be compensated with a higher expected return. Cash is a low risk, low expected return. Debt has a higher risk and a higher expected return. Equity has the highest risk but also offers the highest expected returns.?

Diversification

Because these different investments move differently, diversifying typically creates even better returns than you would expect individually. Using only one category of investment does not always achieve the highest returns relative to the overall risk.?

One of the most important jobs of an Investment Manager is to understand the risk tolerance of their clients. By working with clients to understand their goals, time frame and level of risk, Investment Managers can create a mix of investments in their client’s portfolio that has the highest possible likelihood of achieving their client’s financial goals.?

Ready to take your investment strategy to the next level? Connect with us at?https://www.ozk.com/trust-wealth/ to get started!

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Investment products are not guaranteed by the bank. Not a bank deposit. Not insured by any federal government agency. May go down in value.