The last Risk installment

Last week we discussed the standard investment or risk pyramid. This is a very useful graphic to illustrate how risk plays into our investment strategies. The wider base is where only low-risk investments are placed. These less risky investment vehicles provide stability to the base of our pyramid. As we move up, layer by layer, our investments become more risky. However, as we move up to higher layers, the width of each layer becomes more narrow, meaning we should invest less of our total investment dollar for the more risky plays.

All of that seems obvious. In previous editorials, we have discussed the nature of the risk we take with our stock market plays. Last week on the radio I heard a commercial that said something like, "The Dow is up, the Dow is down. Isn't it about time you invested your money in a risk free money market account? Ours has consistently outperformed other money market accounts by "x" % over the past "y" years...." The implication was, of course, that the market is more risky than their money market. However, we considered one element of risk as "...the chance that we'll earn less than 4 or 5% on our money." If that is the stable return on a money-market account, we have no benefit from the risk taken. Unless! Unless that is the level of risk we can tolerate without losing sleep.

Before we leave this series of risk discussions, lets take a self-exam on risk tolerance. The following is like exams found in the investment literature and will help us understand our own risk tolerance. In this exam we'll find questions that deal with facts (our age, our assets, our obligations) as well as how we react in various circumstances. Exercises like this will help us examine our comfort zones in making investment decisions.

Answer each question, keeping track of the score for each answer:

1. Years before you will retire:
   1. 1 - 5 (0 points)
   2. 5 - 10 (5 points)
   3. 11 - 20 (10 points)
   4. More than 20 (15 points)
   
   
2. Personal assets, home equity, bank accounts, CDs, stocks, mutual funds, bonds:
   1. Less than $5,000 (0 points)
   2. $5,001 to $10,000 (4 points)
   3. $10,001 to $20,000 (6 points)
   4. $20,001 to $50,000 (8 points)
   5. More than $50,000 (10 points)
   
   
3. Will cash be needed from these accounts during the next five years?
   1. Definitely (1 point)
   2. Probably (4 points)
   3. Might (6 points)
   4. Probably not (8 points)
   5. Definitely not (10 points)
   
   
4. You are on a TV game show and can choose one of the following. Which one would you choose?
   1. $1,000 cash (0 points)
   2. A 50% chance of winning $4,000 (3 points)
   3. A 20% chance of winning $10,000 (5 points)
   4. A 5% chance of winning $100,000 (10 points)
   
   
5. You've invested $1,000 in a new business venture started by an acquaintance. The concept still appears sound, but additional capital is needed to actually launch the business. How much money would you be willing to invest -- in addition to your $1,000 -- to have a chance to recover your initial investment and perhaps make a profit?
   1. None. You'd accept your $1,000 loss and not put any more at risk (1 point)
   2. $200 (2 points)
   3. $500 (5 points)
   4. $1,000 (8 points)
   5. More than $1,000 (10 points)
   
   
6. A month after you buy a stock, it jumps 25% in price. Which would you do?
   1. Sell now and take your profit. (0 points)
   2. Hold it and hope it continues to increase. (3 points)
   3. Buy more, expecting it to rise. (5 points)
   
   
7. You buy stock that drops 25% a few weeks later. You still believe the company is sound. What would you decide to do?
   1. Buy additional shares at the new price. (5 points)
   2. Hold the stock and wait for the price to recover. (3 points)
   3. Sell immediately to cut losses short. (0 points)
   
   
8. Your annual salary increase is 5% of your pay. Your boss gives you the option of taking the raise now or being paid a bonus of 50% if the company makes its profit goal for the coming year. However, you won't get the raise or the bonus if the goal isn't met. Which would you take?
   1. The certain 5% raise now. (0 points)
   2. The chance for a 50% bonus. (5 points)

The designers of this self-exam would rate you accordingly:

	Score			Risk Tolerance
	0 - 14			Extremely conservative
	15 - 28			Conservative
	29 - 42			Moderate
	43 - 56			Moderately aggressive
	57 - 70			Aggressive

Stay tuned for next weeks issue where we will begin a series of Guideposts on Technical Analysis.

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