Understand Risk Factors in Investments
A few weeks ago a wealthy 65-year-old walked into Heidi Steiger's office and demanded that she take his $2 million account out of Treasury bills and throw it all in the stock market.
Steiger, managing director of individual asset management at Neuberger & Berman in New York, said no.
"I told him that if he wanted to invest half of it in stocks and half in bonds, we would have something to talk about," she said. "But here was a man who had never taken any risk at all, and he was talking about going to the opposite extreme with money he couldn't replace if he lost it."
This wealthy man is an indication of what thousands of investors _ even those with much less principal _ are doing these days, Steiger said.
They're fed up with low yields on certificates of deposit and Treasury bills so they're flocking to the stock market, which has posted a much more impressive performance lately.
But many have no real concept of the risks they are taking. And an individual's ability to tolerate risk is one of the most important factors in determining how they should invest.
No matter how you choose to invest your money, you should realize you are taking some risk. But the amount and types of risks you take vary greatly with the types of investments you choose.
For example, if you invest in insured bank deposits, Treasury bills and bonds, you are not risking your principal because the investment is backed by the full faith and credit of the U.S. government. But you may find too late that your investment return did not keep pace with the rate of inflation _ the risk of diminished buying power.
But if you invest in the stock market, on the other hand, you are always risking your principal. But, over long periods of time, your average investment returns usually beat the rate of inflation.
To invest well, you must always consider your ability to tolerate these risks. If you don't first consider your risk tolerance _ which translates to how willing and able you are to gamble with your money _ you're likely to make thoughtless and expensive errors.
To weigh your risk tolerance you must generally consider a handful of factors, including your age, your level of affluence, your sophistication about the financial markets and your psychological make-up. While the first three are relatively easy to quantify, the fourth is possibly most important, Steiger said. …