Risk Management

If you're like most investors, you probably think that you're basically safe if your investment principal is in no danger of being lost. Unfortunately, there are only a few types of investments that guarantee no loss of principal, and with those your earnings are likely to be somewhat meager, only keeping up with inflation -- if you're lucky. In other words, you'll have little to no net gain. It's the oldest rule of investing at work: no risk, no reward.If being in the stock market and possibly losing your money causes you to have sleepless nights, then, to be blunt, you probably shouldn't be in the market. There's certainly no shame in that; the stock market is absolutely not for everyone. It might be best for you to invest in money market instruments. Alternatively, you could arrange your portfolio so that a small percentage of it is in the market, and the rest in fixed-income assets.Your investment strategy should be designed to reflect your own risk tolerance. Risk tolerance is your personal capacity, during the time that you hold your investments, to tolerate unfavorable market conditions without making changes. Put differently, it's a measure of how much you can stand to lose without being tempted to abandon your investment program.Your risk tolerance is one of the most important determinants in setting up your portfolio mix. It's more than simply completing a questionnaire. Examining the motivations of past decisions that you've made in your lifetime can be of great aid in assessing your personality and, consequently, your tolerance level. For example, no one likes the idea of losing money. But if anxiety over possibly doing so could cause you to make unwise decisions, then an aggressive investment portfolio is likely not an appropriate choice for you. One of the biggest mistakes that you could make would be for you to go beyond your level of comfort.Before the year 2000, returns in the stock market were excellent for a number of years. People were enticed into believing that the stock market only went up every year. As a consequence, conservative investors suddenly became very aggressive. Many of them paid an expensive price, with some equity portfolios losing as much as fifty percent of their value between 2000 and 2002 because they weren't diversified enough. Without diversity, there's no limit to the amount that you can lose. In managing risk, therefore, it's usually best to start with less and gradually build to a more aggressive portfolio. As you decide that you can accept more risk it can be added a little at a time.You'll also need to consider the amount of time that you have left before you retire. If you have only a few years remaining and you discover that a large gap exists between the total amount of your assets and the amount that you'll need to live comfortably, then you'll probably have to either greatly increase the amount that you're saving or increase your exposure to risk for higher expected investment returns. If, on the other hand, a long period of time remains before retirement, you can afford to do things more conservatively. But, if you discover that you still have a large gap, you may have to follow more aggressive strategies, such as increasing your percentage of equity investments or increasing your retirement plan contributions. Or you might consider pushing back your retirement date. Remember, however, that you must think not in terms of how much you can make, but how much you're willing to lose. If you need to, be sure to seek the help of a professional advisor.