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By: Adrian Mastracci
North Shore News
Business Section, “Loose Change”
Sunday, June 8, 2003
The art and science of accumulating investments
has always involved incurring various degrees
of risk.
No doubt, portfolio statements of the last
three years serve as reminders for investors
who own stocks and funds.
The measurement of risk is relative. Investors
can have different personal experiences with
the same risk factors.
Every investor ought to understand the types
of risks to which the investment portfolio
is exposed. Furthermore, every investor is
well advised to understand the levels of risks
that can be tolerated.
There are many types of risks that a portfolio
may incur, knowingly and otherwise. I would
like to focus attention on three major investment
risks.
I summarize them as:
Ability - the ability
to take the risks is associated with the
investment time
horizon. Someone starting out has more time
to recover from setbacks than someone heading
into retirement.
Willingness - the willingness to
take the risks is associated with the investor
profile. A conservative investor has far less
inclination to incur capital fluctuations then
an aggressive investor.
Need – the need to take risks
is associated with the investment rate of return
required to achieve those personal goals. The
risks of seeking a 6% return are different
than seeking 10%.
The ability, willingness and need to incur
investment risks should always be established
at the outset. Investors who seek professional
counsel know it as part of getting to “know
your client.”
Investors aim to manage investment risks.
Containing the impact of risks means having
to implement investment strategies suitable
for each case.
While there are many choices, these are three
effective investment strategies for containing
risks:
Losses - making portfolio selections
is not about always being right. Part of investing
is about coming to grips with the prospects
of being wrong.
What hurts portfolios the most is not incurring
losses. Rather, it is keeping them far too
long.
The solutions can be simple. Such as adopting
a personal selling strategy if the price drops
25% below the purchase price.
Diversification - diversification
involves spreading the investment bets across
different investment selections. Portfolios
ought to contain a variety of asset classes
that do not all move in the same direction.
Look upon diversification as a welcome and
prudent safeguard. Investors do not want problems
arising in any one investment to ruin their
well-crafted portfolios.
A diversified portfolio reduces investment
risk. If one investment is suffering, the others
should help cushion the rest of the portfolio.
Rebalancing - involves periodic tweaks
to bring the portfolio back into line. Usually
with the appropriate targets and asset mix
set within the investment game plan.
The allocations and weights of the portfolio
selections will drift over time due to market
forces. That drift can become significant,
perhaps also affecting the investment profile.
Consider lightening up on the outperformers
the next time the portfolio is rebalanced.
The other key is buying more of the underperformers.
Oddly enough, many investors choose the exact
opposite. Such as those who have jumped from
stocks to bonds in a major way.
There is one ultimate test to determine the
comfort with portfolio risks. It is whether
the investor lies awake at night wondering
about the investments. Such anxiety is surely
not worth the potential rewards.
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