Anybody can invest all their money in stocks. It's a lot
harder, though, to
keepall that money invested through the
ups and downsthat the stock market will throw at you over
the years.
Those concerns lead most investors to adjust their
portfolios to
control their risk. But how can you be sure that the
amount of risk you're taking is appropriate for you? Trying
to gauge risk tolerance has challenged investors and
financial advisors alike for decades.
The old risk questionnaire
If you've ever dealt with a financial advisor, you're
probably familiar with the fabled risk questionnaire. They're
often only a single page long, with a range of hypothetical
questions that supposedly tell you how willing you are to put
your money at risk.
Too often, though, such questionnaires give an inaccurate
reading of just how much risk you can endure. A study from a
recent issue of
Moneydiscussed how big a disconnect there is between
the amount of risk many people think they should take versus
what they can
handle emotionallyduring down markets.
In particular, many advisors will recommend that younger
investors put most of their money into the stock market. Yet
according to a research company cited in the article,
FinaMetrica, very few investors -- just 7% -- are equipped to
deal with the volatility that results from having as much as
75% of their portfolio invested in stocks. Just one in 100
investors can handle an 87% stock exposure.
Lots of different risks
Another problem with assessing risk is that there are
so many different types of risk that investors face. Although
most people focus on overall prospective losses, there are
other twists on the concept of risk that you might not
immediately consider.
For instance, missing out on gains can be even more
damaging than incurring big losses. Part of the reason for
taking big risks in stocks is to reap
potentially huge profitswhen you choose wisely.
Some people, though, can stomach risk on the downside but
like to take profits early. That particular type of risk
aversion can turn
speculative investmentslike the ones many investors took
in stocks like
Ford Motor (NYSE: F),
MGM Mirage (NYSE: MGM), and
Bank of America (NYSE: BAC) into losing
propositions: You still risk your whole investment, but you
reap only 50% or 100% gains, rather than the four- and
five-baggers you would have gotten if you'd stuck with those
stocks throughout the rally.
Lacking conviction
In addition, even when you make good investment
choices, they don't always reward you immediately. For
instance, if you had bought the following stocks a year ago,
you would have been sitting on some
serious lossesby early March. If you weren't prepared for
such losses, you might have dumped your shares. Yet just look
at the gains you would have missed by selling at what would
eventually prove to be exactly the wrong time:
Stock
Loss From 10/9/2008 to 3/9/2009
Gain From 3/9/2009 to 10/9/2009
Whole Foods Market (Nasdaq: WFMI)
(21.8%)
169.3%
Lowe's Companies (NYSE: LOW)
(24.4%)
54.4%
Bed Bath & Beyond
(25.3%)
88.6% Continued... |