Investment: Getting real about risk
How to assess your tolerance for risk when you allocate your assets
All asset allocation strategies are basically the same, said Steve Garmhausen in the Los Angeles Times. The idea is to find some mix of stocks, bonds, and other assets—then sit tight no matter what happens in the market. But “that didn’t go too well for many people last year, who either spent restless nights worrying about their investments or threw their asset allocations out the window so they could get some sleep.” Were you one of them? Then it’s time to reassess your risk tolerance.
Getting a handle on just how much risk you can stomach is no easy task, said George Mannes in Money. Advisors and fund companies have risk-tolerance questionnaires to fill out, but these are “typically too brief to deliver much insight.” Most of all, they fail to make one very important distinction: “Your capacity for risk is different from your appetite for it.” Young investors, for instance, can profit from aggressive portfolios, heavy in stock. But not if they eventually panic-sell, as many investors did in March. For an accurate picture of the “psychological aspects of risk,” take FinaMetrica’s online test (Myrisktolerance.com). Do it while you’re still skittish, so you have a “benchmark” to refer to when you start “feeling cocky” again.
Then find out how much risk you’re actually carrying right now, said Tony Christensen in Forbes.com. “It’s amazing how many new clients walk through my door with no idea how much risk is built into their portfolios.” To calculate the overall risk presented by any individual investment—or your entire portfolio—take the standard deviation of its price performance and multiply it by 2.5. That’s “how much you should be prepared to lose.”
Actually, I can save you the math, said Felix Salmon in Reuters.com. “You had an idea, back in March, of what your risk appetite really was.” Think about how much of a loss you were willing to accept at that point, when things seemed darkest. Most people will want to protect themselves by rebalancing out of equities and into other funds. Yes, you’ll have fewer upside profits to look forward to, but “unless you can afford to see your stocks fall, you shouldn’t be invested in them.”