There is no simple answer to this question but first, we must define what “risk” is. Many people see stock market risk as the only kind of risk. In reality, there are many kinds of risk. Stock market risk is one. Others include interest rate risk, credit risk, liquidity risk, concentration risk and more. For example, investing stocks and mutual funds carries market risk. The overall level of volatility depends heavily on investment selection. CDs are a potential alternative to this. CDs do not carry market risk but are very sensitive to interest rates and thus carry interest rate risk. CDs, money market accounts and cash also carry inflation risk as an overconcentration in these may not keep up with inflation and could reduce your purchasing power.

This is the reason why it is important to have investments that are well diversified, tax conscious and are in alignment with your risk and return expectations across multiple asset classes. Although risk can never be completely eliminated, having an investment strategy that aligns with your goals can mitigate some of it.

A mutual fund is a single investment that contains a basket of other investments. Stocks and bonds are the most common securities to be held in mutual funds but mutual funds can hold other types of investments, including investments that are normally not available to the general public such as hedge strategies and private equity. Mutual funds do not trade throughout the day like stocks. Instead, a mutual fund’s value is determined by its net asset value (NAV). The NAV is calculated once per day at the end of the trading day by adding the funds assets, subtracting liabilities and dividing by the total number of outstanding shares.

ETFs, like mutual funds, contain a basket of investments. There are some differences from mutual funds. ETFs are traded like stocks throughout the trading day, unlike mutual funds which trade only once per day. There are exceptions to this but ETFs also tend to be more tax efficient than mutual funds.

Mutual fund managers rebalance by buying and selling securities held within the fund which can create taxable events for shareholders. This doesn’t always create capital gains as sometimes mutual fund managers are able to use tax mitigation strategies during the rebalancing process.

An ETF issuer can create or redeem “creation units” with authorized participants (APs), usually a broker-dealer. The AP delivers securities to the ETF issuer “in-kind” and in exchange, the ETF issuer delivers new ETF shares to the AP. This results in fewer taxable events for shareholders.

A bond is a debt instrument that can be issued by governments or private corporations. Bonds usually pay an interest rate to the bondholder referred to as the “coupon.”

The most common types of bonds issued in the United States are government bonds, issued by the US government, municipal bonds and corporate bonds.

US government bonds are considered to be very safe. The US treasury issues T-Bills, notes, longer duration bonds and Treasury Inflation Protected Securities (TIPS).

In the case of TIPS, unlike other bonds, the principal of a TIPS can go up or down and because the interest rate is based on the principal, the rate can also go up and down. The value of a TIPS goes up with inflation and down with deflation.

Municipal bonds are bonds issued by a state or local government. Most municipal bonds are divided up into separate categories of general obligation bonds (GOs) and revenue bonds. GOs are backed by the full faith and credit of the issuing government entity. They are used to fund projects like schools and parks. Revenue bonds are backed by revenues sourced directly from the project or by taxes assessed by the government entity. Because revenue bonds are not backed by the full faith and credit of the issuing government entity, they are considered to have higher risk.

Corporate bonds are issued by private corporations to fund things like expansions, acquisitions and debt refinancing. Because they are not backed by a government entity, they are considered to be higher risk than government bonds but often have higher yields as well.

Zero coupon bonds are bonds that do not contain a coupon/interest rate but are instead issued at a discount and pay face value at maturity.

US Government bonds, municipal bonds and corporate bonds are all taxed differently. US treasuries are generally exempt from state and local taxes but are not exempt from federal taxes. Municipal bonds are tax exempt from federal taxes and state taxes in the state where the bond was issued. An exception to this is when a bond is purchased at a discount on the secondary market. The discount is not tax exempt.

There are many other subgroups of bonds in addition to these.

Cost basis is the price at which an investment was purchased. This is necessary for determining how the investment will be taxed at the time it is sold. For the purposes of a taxable investment, the difference in price paid and price sold will be taxable, or in the case of a capital loss, could reduce tax liability.

Capital gains are profits that result from the purchase and sale of an asset. Long term capital gains are profits from the sale of an asset that has been held for more than one year. Short term capital gains are profits from the sale of an asset that has been held for one year or less.

Long term capital gains are preferred to short term capital gains as they are taxed at a lower rate than short term capital gains. Short term capital gains are taxed at your regular income tax bracket.

A market index is a snapshot of a group of investments that we use as a benchmark to gauge the performance of a sector of the market. There are many indices that cover stocks, fixed income products, commodities and other investments in countries all across the world. Some notable examples include: S&P 500, Dow Jones, Nasdaq Composite, Russell 2000 and MSCI (Morgan Stanley Capital International).

Values based investing refers making investments that are in alignment with your personal values and beliefs. While some areas of values based investment are still an emerging market, we are seeing growth in the areas of environmental social and governance (ESG), Christian financial strategies and Halal investment.

While there is no established definition of what constitutes ESG investing, the strategy typically involves investing in companies that value issues like climate change, biodiversity, human rights and diversity of employees and board composition while divesting from companies that do not.

Christian financial strategies use a similar method of positive inclusion and negative screening of investments to avoid industries related to things like abortion, pornography, alcohol and tobacco.

Halal investing focuses on investment strategies that follow Islamic Shariah principles. Most conventional fixed income investments could constitute usury. Halal investment strategies avoid conventional bonds that earn interest. Halal investment also avoids equity investments in industries that would violate Shariah principles.

Actively managed funds have a fund manager that is buying, selling and holding investments to try to beat a market index or achieve some other objective of the fund. For funds that are passively managed, they are usually tracking an index and attempting to replicate it. Actively managed funds tend to have higher expense ratios while passively managed funds tend to have lower expense ratios.

An expense ratio is the annual operating cost of an investment such as a mutual fund or ETF. The expense ratio is baked into the value of the fund. A higher expense ratio will reduce the value of the fund.

A fiduciary in the context of investing, is a financial advisor that is legally bound to act in your best interest. There are several duties that the advisor must adhere to.

The first is the duty of care. This duty requires the fiduciary to inform themselves of material information necessary to make sound judgments, prior to making a decision that could affect the client.

The duty of loyalty requires a fiduciary to act in the best interest of the client, putting their interests before that of the advisor or firm.

The duty of good faith requires the fiduciary to have an honest intent to perform their duties in the best interest of the client.

The duty of disclosure requires the fiduciary to provide all information that is necessary for the client to make an informed decision.

The duty of confidentiality requires the fiduciary to keep client information private, only releasing information to third parties with the consent of the client or when required by law.

The duty of prudence requires the fiduciary to exercise duties with care, skill and caution.

A broker-dealer is a firm that acts as a broker when facilitating or executing orders on behalf of clients and dealer when it trades from its own inventory. Broker-dealers provide a range of services with some providing financial advice through registered representatives of the firm or may simply act as a custodian of investments for other firms.

A registered investment adviser is a firm that provides investment advice for a fee, rather than be compensated by commission. RIAs act in a fiduciary capacity and manage investments but typically utilize a separate firm as custodian to make trades. Broker-dealers employ registered representatives to provide investment advice while RIAs will employ investment adviser representatives (IARs) to provide investment advice.

A common misconception is in relation to the standard of care of broker-dealers relative to registered investment advisers. The SEC established Regulation Best Interest (Reg BI) which became effective June 30, 2020. Historically, broker-dealers were subject to the suitability standard for investment recommendations. Under this standard of care, investments only had to be suitable, even if the registered representative could have recommended another product that was more appropriate.

Reg BI removed the suitability standard for broker-dealers and replaced it with the best interest standard. Unlike the suitability standard, broker-dealers and their registered representatives must ensure that a recommendation is in the client’s best interest. This standard still does not rise to the fiduciary standard as the fiduciary relationship that exists in RIAs is one where the IAR provides ongoing financial advice, rather than a one-time recommendation. Registered representatives only have to ensure that the investment is in the client’s best interest at the time that the investment recommendation is made.

It is common for firms to be hybrid firms where they are a broker-dealer and registered investment adviser. These firms employ hybrid registered representatives and IARs that can provide fee based investment advice and can also use commissionable products.

The best way to see the background of a registered financial professional is through FINRA’s BrokerCheck platform. BrokerCheck will provide information about the financial professional such as years of experience, prior firms, which exams they have passed, official complaints and more. This can be found at https://brokercheck.finra.org/