Crowdfund Investing For Dummies
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If you haven’t been scared you away from crowdfund investing yet, that means you probably have some tolerance for financial risk. How much tolerance? That’s a question only you can answer (ideally with guidance from a financial advisor).

Creating an investment portfolio that meets your needs demands first assessing your level of risk tolerance. If you have nerves of steel and can withstand rocky financial times without selling every investment at the worst possible moment (when its value has fallen to the floor), you’re pretty high on the risk tolerance scale.

If you lie awake at night worrying that your stock index mutual fund ticked a quarter of a percent lower that day, you’re in an entirely different risk zone.

Depending on how much risk you can stomach and what your long-term goals are, you should diversify your investments — spread them among various asset classes — accordingly. The term asset classes refers to groups of investments that share certain characteristics, including risk.

Low-risk government bonds constitute one asset class, and high-risk junk bonds constitute a very different asset class. In between you have federal agency bonds, corporate bonds, international bonds, and more.

Within the equity world, you have large-cap stocks, small-cap stocks, international stocks, value stocks, growth stocks, emerging market stocks, and more. (The word cap here refers to capitalization, which is an estimate of a company’s value arrived at by multiplying its total number of outstanding shares by the current price of a single share.)

For every asset class, this truism holds: The lower the risk it represents, the lower the return (or potential return) it offers. Conversely, the higher the risk it represents, the higher the return (or potential return) it offers. That’s why people don’t get rich quick buying government bonds, and it’s why people who take chances on risky stock classes have a fairly good chance of ending up either richly rewarded or completely broke.

Higher-risk asset classes also tend to be much more volatile than lower risk asset classes. If you buy a U.S. Treasury bond, you don’t expect a lot of volatility from that investment; you know how much return you’ll be getting.

If you buy stocks in an emerging-market nation, on the other hand, you don’t have a clue what your return will be in any given year. You hope to jump on the roller coaster while the car is pointing uphill, but you never know when you’ll reach the crest and start rushing down the other side.

Many financial advisors make their living helping people determine how to craft a portfolio that fits all their needs, including their risk tolerance and need for returns. Most people (though certainly not all) find that as they get closer to reaching their long-term goals, such as retirement, their risk tolerance decreases.

Therefore, a portfolio cannot be a static thing; as your life circumstances change, you and your financial advisor must be prepared to adjust your investments accordingly.

The beauty of diversifying your portfolio with a variety of asset classes is that you can still invest in some of the high-risk classes, including startups and small businesses, without risking your long-term goals. As long as you know that crowdfund investing is firmly planted on the high-risk end of the investment spectrum, and as long as you maintain strict control over your investment choices, you absolutely can fit it into your portfolio.

Diagram showing how to diversify an investment portfolio.

Just don’t assume that all (or even any) of your crowdfund investments will turn into the next Google. Chances are very, very good that they won’t.

About This Article

This article is from the book:

About the book authors:

Sherwood Neiss, Jason W. Best, and Zak Cassady-Dorion are the founders of Startup Exemption (developers of the crowdfund investing framework used in the 2012 JOBS Act). They deeply understand the process, rules, disclosures, and risks of capital formation from both the entrepreneur's and the investor's points of view.

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