Risk Management
Investment Risk
3 Ways Almost All Investors Take on Too Much Risk
What’s your risk tolerance? It’s a standard question in investment management, and you might have a very clear answer. But whatever your risk tolerance, you’re probably taking on a lot more than you realize -- and that additional risk is almost certainly costing you. Don’t let your psychology get in the way of your investment plans: read on for three commonly overlooked sources of portfolio risk and how to fix them. You’re too...more
How to Plan for Risk in Your Portfolio by Knowing Your Tolerance and Capacity
Summary: Tolerance and capacity are two ingredients of risk when it comes to investments and retirement planning. We look at what they are, and what kind of critical impacts they can create when planning for your golden years. When we think about recipes for well-funded retirement plans we often start with some basic concepts. One of them is that investments are at the root of preparing for our post-work years. Packed into our investment portfolios, however, is a separate...more
Measuring Investment Risk and the Significance of Sharpe Ratio
Investment pros borrow a tool from the statisticians'standard deviation'to measure investment risk. It shows the range of returns that investments are likely to earn over a given period of time and it has two sides, the out-performance and the under-performance of an average rate of return. For example, let's look at the S&P 500 Stock Index1 and consider the average rate of return 12.1% and standard deviation +/-19% for 100 years. The standard deviation tells us that a relatively bad year...more
The Effects of Risk (Volatility) on Returns
If you could increase your investment success over the long term, would that interest you? As I progress through this paper, I will provide proof that your investment account is significantly impacted by two related factors: 1) the importance of consistency, and 2) the detriment of losses. First, let me recap some statistical information I learned after reading a report written by economist, John Mauldin. Mauldin writes "in the 103 years from 1900 through 2002, the annual change for the Dow...more
Do You Know Your Investment Risk Tolerance?
At various time in our lives, most of us are compelled to look at whether we are taking the appropriate amount of risk in our investment portfolios regarding our lives and our lifestyles. The subject can be confusing because, on the one hand, risk-taking resides at the heart of capitalism and is responsible for a large part of the growth of the economy. However, on the other hand, we each want to sleep well and be good steady providers for our families. What is risk? Basically, it is the...more
How to Protect Your Investment Portfolio and Mitigate Downside Risk
Investing your life's savings is different from investing speculative assets. For core assets, assets you can not afford to lose, safety becomes as important as growth. However, in order to capture growth one must invest in equities. Yet the more an investor places in stocks, the more the investor increases his risk. Diversification along various asset classes might reduce risk somewhat, but the cost of taking more assets away from stocks by investing in bonds and money instruments leads to...more
How to Protect Your Portfolio in Turbulent Times
Many investors need equity returns to build wealth over the long term. Unfortunately, as individuals, we sometimes find it difficult to endure the sharp declines that we often experience in the equity markets. This was particularly true from late 1999 through early 2003. As investors, we should understand that risk is necessary to pursue higher returns. However, the correlation between risk and reward illustrates that higher returns, more often than not, experience higher volatility. This...more
Growth and Value Investing: What's Your Style?
Just as people shop for clothes according to personal tastes, some people select stocks, mutual funds, and investment divisions of variable contracts by styles. Two of the most popular investment styles in today's markets are "growth" and "value" investing. The prices of stocks change every day. Over a moth or two, an individual stock's prices can rise or fall 10%, 20% or more. In a bull (optimistic) market, growth stocks are often viewed as the equivalent of premium brands. Value...more
Minimizing Your Risk of Loss in Your Investments
In our last article, we talked about the role of asset allocation in an investment plan. The topic this time is minimizing risk. It's a RISKY topic but let's start by stating the obvious, most people overly focus on returns and not enough on risk. Returns are fun to think about and investors often start counting their rewards while still in the process of making an investment despite significant uncertainty. Wall Street relies on this tendency to sell all kinds of investments to...more
Protecting Your Portfolio or Taking Profits
Having a plan to preserve your gains and to manage your losses, should be the most important part of your investment strategy. I have noticed that most long term profitable investment strategies are not the ones with the best selection strategy, but the systems with a disciplined risk management strategy. A good example is the Bear market of the 2000-2002, which wiped out all the gains accumulated by the stock market since 1997. The most commonly used risk and profit management strategy is to...more
Have You Assessed Your Risk Tolerance?
While investors want the highest returns possible, returns compensate you for the risks you take - higher risks are generally rewarded with higher returns. Thus, you need to assess how much risk you are willing to take to obtain potentially higher returns. However, this can be a difficult task. It is one thing to theoretically answer questions about how you would react in different circumstances and quite another to actually watch your investments decrease significantly in value. What you are...more
Risk Management vs. Letting Them Ride
Over the last 10 years we have experiencing a market period like no other. Certainly the market sell-off of 2000-2002 was so much tougher than 1987 "bear market" (that lasted for arguably a couple of months), 1989-1990 recession sell-off, 1994's stealth bear market, 1996's summer technology sell-off, 1997's prelude to the Asian flu, and 1998's Asian flu. Even some brokers who were around in 1974-1975 have said that the 2000 to 2002 sell-off was much harsher to investors. One of the things that...more
The Percent Risk Model: Size Does Matter
It's time now, once again, to dispel those ugly rumors that "size doesn't matter." Indeed, size does matter in investing, and it matters just as unambiguously as when parallel parking a Buick in heavy traffic. The difference being (among other things) that in parking a 'land shark' like a Buick, it is the 3-mile long hood and the cavernous trunk, that clouds up the process. In trading or investing, it is the even more often 'inopportune' impact of emotions that clouds our clarity and takes us...more
Reassessing Your Risk Tolerance
The investments you choose throughout your life will likely vary based on the degree of risk you are willing to assume and the average return you can expect. Generally, the rule of thumb is that the greater the risk assumed, the greater the potential return on that investment. But finding the right balance between the return you desire and the amount of risk you can handle can be challenging. What was right for you yesterday might not be right for you today. The last few years have...more
Risk is a four-letter word. To most investors, risk translates into the chances that a particular investment will lose value over a period of time. This is called Market Risk. While Market Risk is certainly a legitimate measure of risk, it fails to recognize other forms of risk that each investor should carefully consider. Volatility Risk Investment professionals typically measure risk based on the volatility of returns. Investments with high volatility carry greater risk. Indeed,...more
Putting Risk in Its Place in Your Portfolio: Part 1
Most investors see risk as the chance that they may lose money. But academics and statisticians, who have been studying risk in the financial markets for the past half-century, define risk as measurable uncertainty. And that additional notion "that risk can be measured" makes all the difference. If you can quantify risk, you can use the information to become a smarter investor. You can identify the securities you own that have the most risk. You can check your overall portfolio risk level and...more
Putting Risk in Its Place in Your Portfolio: Part 2
Yes this is not fun to learn, but for those of you who have lost a great deal of money (over 30%) in the past, want to know why it may have been avoidable and ways to help prevent it the next time, read on!! In part one of this series, we explained two measures of risk, standard deviation and beta. As we mentioned, standard deviation and beta are good measurements of the risk associated with individual assets on a stand-alone basis, but are not in and of themselves the primary keys to...more
Putting Risk in Its Place in Your Portfolio: Part 3
In part one of this series, we explained two measures of risk, standard deviation and beta. In part two we talked about correlation and how it is the key driver of total portfolio risk (while most investors only consider beta and standard deviation). This is all well and fine, but we?ve only spoken theoretically up to this point. The real question most of you are probably asking is, ?Fine, but how do I identify these alternative assets that are not correlated with the stock and bond...more
Putting Risk in Its Place in Your Portfolio: Part 4
In part one of this series, we explained two measures of risk, standard deviation and beta. In part two we talked about correlation and how it is the key driver of total portfolio risk (while most investors only consider beta and standard deviation). In part three we defined ?alternative assets? and looked at a couple of these alternative asset classes; namely real estate and commodities and how their returns correlated to the S&P 500. In part four, we will go further in depth on this...more
Putting Risk in Its Place in Your Portfolio: Part 5
Previously we have discussed risk as it relates to investments on a stand-alone basis, how correlation is the key driver of portfolio risk, various alternative asset classes and historical risk and return profiles calculated through using various combinations of indices over various periods of time. In this article we?ll discuss why we (and some of the top investors and economists of all time) don't foresee equity returns over the next 7 to 10 years being comparable to those experienced over...more
Ruminations on Risk and Return
Many people are familiar with the widely accepted notion that risk and return go together, but are unaware that it is an incomplete and misleading formulation. Let me restate it thus: "Return equals risk, which doesn't equal return." Obviously an explanation is in order. Return equals risk. Almost certainly if someone earns very high returns they ran very high risks to do so - though it may not be obvious in hindsight. Indeed, many people who become phenomenally wealthy (not just...more
All investments, whether fixed income or equity, are exposed to some type of risk. The goal of investing is to balance the return earned from those investments with a level of risk an individual considers appropriate. Fixed income investments are generally exposed to inflation, reinvestment and credit risks. Inflation risk comes into play because the income stream coming from the fixed income investment remains constant while inflation eats away at its purchasing power each year. This...more