Volatile market prompts fresh look at risk tolerance

Posted: Friday, August 09, 2002

NEW YORK (AP) -- The traditional definition of risk tolerance is ''an investor's ability to handle declines in the value of his or her investments.''

These days, a better definition might be ''the ability to sleep at night when your portfolio is tanking with the stock market.''

With half of Americans invested in equities -- through ownership of stock mutual funds, contributions to 401(k) retirement accounts or straight-up share purchases -- the question of how much risk people can tolerate has been sorely tested by recent market volatility.

''We all have a good measure of risk tolerance when we run a yellow light,'' said Gary Gensler, a former U.S. Treasury official who is co-author of ''The Great Mutual Fund Trap.'' ''We get away with it for a while, then we get a ticket. So we recalibrate and don't run so many lights.''

When it comes to investing, ''we don't recalibrate very often because we don't run into market 'yellow lights' every day,'' he added.

With the stock market down sharply so far this year -- and threatening to post its third consecutive annual loss -- a lot of savers are looking hard at risk.

''I'm besieged by calls,'' said Gary Schatsky, a fee-only financial planner in New York. ''Even people with modest losses are uncomfortable and concerned.''

Part of the problem, he said, is that many investors haven't been asked the right questions about risk.

''Brokerage companies ask, 'How much do you want to make?'' he said. ''I start with the question, 'How much are you ready to lose?''

A number of factors need to be considered in evaluating risk tolerance: How old are you? How much money do have, and how much is available for investment? How soon do you need the money?

''If you're closer in age to retirement, or closer to needing money to send your children to college, you're going to want to take fewer risks,'' Gensler pointed out. ''If your house is paid for and you have insurance and you know you'll have a pension, you're probably more willing to take risks with the other money you have.''

Financial advisers can help investors assess their ability to deal with risk, and there are several do-it-yourself calculators on the Internet, especially at mutual fund and brokerage sites. One free site that specializes in risk assessment is www.riskgrades.com, which can even help model a portfolio in line with an investor's needs.

The importance of knowing your risk tolerance is that it's key to determining how you allocate your investment dollars. That's because a good balance of stocks, bonds and cash provides the best defense in the long run against investment risk.

One rule of thumb is to subtract your age from 100, and that's the maximum percentage of your investable assets that should be in stocks. For example, a 45-year-old woman should consider having 55 percent of her investments in stocks, with the rest in bonds and money market funds, certificates of deposit or cash. A 55-year-old woman might limit her stock holdings to 45 percent, with the rest in other investments.

Gensler suggested that a ''balanced'' portfolio today might include 60 percent in equities -- perhaps 45 percent in a broad market index fund and 15 percent in an international index fund -- 30 percent in a bond fund and 10 percent in cash or CDs.

Even the most conservative, risk-averse investor should have some exposure to stocks, even if it's just 20 percent of his or her investments, Schatsky said.

''There are risks other than market risks,'' he said. ''A 100 percent portfolio of cash is risky. Why? Over any long period of time, you're almost guaranteed to lose when you take inflation and taxes into account.''

Still, he said, the ability to tolerate risk is a very personal thing.

''We can measure with some accuracy the level of loss that could be incurred where a family or individual wouldn't be financially destroyed,'' Schatsky said. ''But measuring temperament is more difficult -- like the guy whose portfolio is brilliantly allocated and performing well, but he can't sleep at night.''

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