Suzanna de Baca

Reducing Your Investment Risk – 3 Questions to Answer.
January 17, 2007

Recently, I quoted my beloved Grandma Dorothy, who told us not to put all our eggs in one basket – but, unfortunately, Grandma did not specify exactly how many or what kind of baskets we need.That column discussed the benefits of reducing your investment risk around through asset allocation, but how do you know how much, what and where you should invest?

You wouldn’t just build a house or other structure without a blueprint, and similarly, you should have an overall plan for your investment mix.An asset allocation is just that – a plan of action to help you systematically go through the process of constructing a sound portfolio.

Before even picking individual investments or mutual funds, there are 3 key questions you should ask yourself to help you determine your asset allocation.

3 Key Questions:

1. What is My Risk Tolerance?
   Translated into simple language, risk tolerance asks “How much are you willing to lose?”You may be the type of person that loves to gamble at poker or craps, but your investment time horizon is probably longer than one night in Vegas.If you have low risk tolerance, conservative investments like bonds or cash are the most appropriate.For someone with a medium risk tolerance, a mix of large cap stocks and bonds will provide balance, and for an aggressive investor, a variety of different kinds of stocks can provide attractive returns for the risk you’re taking.

2. What is My Time Horizon?
   When are you going to need the money in question?For example, if the funds you’re allocating are in a retirement plan, the earliest you can withdraw them without penalty is age 59 ½, so that determines your time horizon for those assets.The farther away in time your goals are, the higher your risk tolerance can be.This because younger people have longer to recover from a potential setback, such as market fluctuations, than older people who may need to live off their retirement assets sooner rather than later. On the other hand, novice investors often want to build their confidence at a modest level of risk, which makes diversification even more important.

3. What are my Return Goals?
   Once you’ve determined your time horizon and your general tolerance for risk, a financial professional can help you calculate how much money you’ll need to maintain (or improve) your lifestyle in retirement.
   You will benefit by targeting a realistic amount, rather than saying, “I need ONE BILLION DOLLARS in 20 years!”Your advisor can help you back out the return you need to achieve your goal, for example, 7% or 9% per year after tax performance, and then you can set your allocation accordingly using the proper mix of stocks, bonds, cash or other investments.
   Once you’ve come up with an overall plan, you can start selecting the right investment vehicles for each asset class.We’ll cover that in a future column, but for now, know that a good allocation is like well-executed and thorough plan drawings that will provide you with a good guide as you begin your project.

PAS is a member NASD, SIPC.

Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as tax, legal or investment advice. Although the information has been gathered from sources believed reliable, please note that individual situations can vary, therefore the information should be relied upon when coordinated with individual professional advice.

Posted by Suzanna de Baca on January 17, 2007 | Comments (0)