What four-letter word should pop into mind when the stock market takes a harrowing nose dive?
Risk is the potential for realizing low returns or even losing money, possibly preventing you from meeting important objectives, like sending your kids to the college of their choice or having the retirement lifestyle you crave.
Assessing your risk tolerance, however, can be tricky. You must consider not only how much risk you can afford to take but also how much risk you can stand to take. Determining how much risk you can stand—your temperamental tolerance for risk—is more difficult. It isn't quantifiable.
To that end, many financial advisers, brokerage firms, and mutual-fund companies have created risk quizzes to help people determine whether they are conservative, moderate or aggressive investors. Some firms that offer such quizzes include Merrill Lynch, T. Rowe Price Associates Inc., Baltimore, Zurich Group Inc.'s Scudder Kemper Investments Inc., New York, and Vanguard Group in Malvern, Pa.
Typically, risk questionnaires include 7 to 10 questions about a person's investing experience, financial security and tendency to make risky or conservative choices.
The benefit of the questionnaires is that they are an objective resource people can use to get at least a rough idea of their risk tolerance. "It's impossible for someone to assess their risk tolerance alone," says Mr. Bernstein. "I may say I don't like risk, yet will take more risk than the average person."
Many experts warn, however, that the questionnaires should be used simply as a first step to assessing risk tolerance. The second step, many experts agree, is to ask yourself some difficult questions, such as: How much can you stand to lose over the long term?
"Most people can stand to lose a heck of a lot temporarily," says Mr. Schatsky. The real acid test, he says, is how much of your portfolio's value you can stand to lose over months or years.
As it turns out, most people rank as middle-of-the-road risk-takers, say several advisers. "Only about 10% to 15% of my clients are aggressive," says Mr. Roge.
What's Your Risk Tolerance?
1. Just 60 days after you put money into an investment, its price falls 20 percent. Assuming none of the fundamentals have changed, what would you do?
a. Sell to avoid further worry and try something else b. Do nothing and wait for the investment to come back c. Buy more. It was a good investment before; now it's a cheap investment, too.
2. Now look at the previous question another way. Your investment fell 20 percent, but it's part of a portfolio being used to meet investment goals with three different time horizons.
2A. What would you do if the goal were five years away?
The task of life-cycle financial planning is a formidable one for most people. It is not surprising that a whole industry has sprung up to provide personal financial advice.
An interest in an asset held by a trustee for the benefit of another person.
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