Risk is an essential part of investing
I have always admonished clients and seminar attendees to take a realistic look at determining what it takes to build a reasonable retirement nest egg.In the real world of finance, investors need to assume an average riskposition in order to have any hope of accumulating an adequate retirement fund.By accepting a reasonable level of risk in your overall investment portfolio, you can expect a decent return. Conversely, by assuming a low level, or conservative, risk position during your accumulation years (ages 20-65), you’ll surely end up as a retiree with far less than you need to lead a comfortable life.A variety of questionnaires and quizzes are used to determine just where individual investors register on the investment risk scale. With the results in hand, investments are suggested that match the investor’s risk profile, or tolerance.Some time ago, a reader had taken a “risk quiz” and fell below (more conservative) my recommended average risk investing position. The question was how could I suggest that investors be something that they’re not, i.e., become risk takers at a level beyond that indicated as appropriate by the results of their risk tolerance quiz.While my remarks here have general application, the issue of risk tolerance is particularly important for participants in retirement plans such as the 401(k) and the like. As such, it is to investors in such plans, like the aforementioned reader, that I direct these comments.A risk tolerance quiz is similar to a nest egg worksheet. In both cases, these tools are meant to provide guidance to the beginner or less-experienced investor in putting together an investment plan that is consonant with their appetite for risk and long-term goals.However, unless you’re financially literate, the results of a risk questionnaire are of questionable value. And, participants in self-directed retirement plans are particularly susceptible to “getting it wrong.”One of the first things a new retirement-plan enrollee does is to take a quiz or work through a checklist of questions to determine his/her level of risk tolerance. Generally, the enrollee is not familiar with investing concepts, the terminology is confusing, and the idea of taking risk is a bit intimidating. In addition, behavioral finance research has produced numerous studies that show that most individual investors are “risk averse.”As a consequence, the natural reaction of the less-experienced investing public (about 9 out of ten of us) is to play it safe. Thus, for example, 401(k) plans have an egregiously high percentage (27 percent) of the participants’ investments in money market and stable value accounts. This “safe” but low-return asset class is simply not an appropriate one for the accumulation period of one’s retirement investing.”By completing the following quiz, you can measure how comfortable you are about investing.” This guidance is typical of what you’ll find in the how-to materials provided to retirement plan participants. It all appears to be fairly straightforward – answer a few questions and, bingo, you’ve got your risk tolerance pegged.But, doesn’t it seem illogical to ask people to take a “test” on a subject matter about which they have little or no knowledge. The risk quiz approach is too simplistic – it lacks the depth and breadth of content needed for a substantive treatment of the issue. Results from such an exercise are going to be of questionable value, and yet thousands, if not millions, of retirement plan participants have determined the course of their long-term investing on just such a basis.I strongly suggest that retirement-plan participants discuss investment risk with your plan administrator and/or plan provider. Getting a proper fix on this issue is an important component of successful investing. Richard Loth is managing principal of Mentor Investing, and is an independent registered investment adviser. He can be reached at email@example.com or calling 328-5591.Vail Daily, Vail, Colorado
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