Calculating risk can help achieve investing goals

How much risk are you willing to take with your investments?

Your answer is likely linked to how well the stock market is doing these days. If your investments are up, your confidence and appetite for risk are up – any stock you touch is gold.

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But if the market reverses and plummets, your appetite for risk will likely disappear. Suddenly you’re holding nothing but fool’s gold. The loss of money turns you into a conservative investor who wouldn’t touch a risky biotech stock with a 90-foot pole.

Those wild swings of risk tolerance are what investment advisers try to avoid and balance. Risk isn’t about what the market is doing today, they say. It’s more about what the investor wants to do tomorrow and beyond.

When and where do you want to retire? When and how many children will you be putting through college?

When and where do you want to travel? These are the questions Nancy Stevens asks her clients at First Western Trust Bank, a Denver-based investment advisory firm with an office in Boulder.

Stevens, the bank’s managing director, said she takes each goal and then determines what sort of risk an investor can take to obtain the goal. A client’s tolerance for risk is determined upfront before investing decisions are made.

“We’re trying to get their focus on where they want to get to, and get their focus off what’s happening in the market short-term,” Stevens said. “Short-term decisions lead to impulsive buying and selling behavior, which usually doesn’t work well.”

Stevens said the best way to figure out one’s life goals is to have a personal conversation with clients. During the conversation a lot comes out about what an investor wants to accomplish. “All of a sudden you’re finding out that they want to travel around the world, or buy a second home,” she said.

The person’s overall tolerance for risk is also a factor. “You have to create a portfolio (so) that the investor can sleep at night,´ said Robert Pyle, president of Diversified Asset Management Inc.

Pyle’s leading theory is to diversify clients’ investments. “It’s how all your investments work together,” he said. “Obviously emerging markets are riskier, but a small portion of emerging markets in your portfolio helps your diversification and actually reduces risk.”

Every investor’s risk amount is different, but there are some broad theories, he said.

For example, someone who is younger, accepting to view the market long term and/or needs to make some more money is a candidate for a higher-risk portfolio. Conversely, someone who is older, gets nervous about short-term swings in the market, and/or has a lot of assets to begin with is candidate for a lower-risk portfolio.

According to Pyle, risk calculation also depends if you are withdrawing funds or depositing.

A safe withdrawal rate for retirement is about 4 percent, he said. “We look to design a portfolio that can sustain that withdrawal rate for the whole retirement – about 30 years,” he said.

If you’re an investor dabbling in some individual stocks, there are some market measurements to help calculate the risk of those investments. One of the most referred to is a statistical measurement called beta.

The beta of a stock is a measure of a stock’s volatility in relation to the market. The market is given a beta value of one. So, any stock with a beta higher than one tends to be more volatile and riskier, but it could carry large rewards. Stocks with a beta of less than one tend to be more stable than the market and less risky.

The beta value of a stock can be found with most online stock quotes. As with any investment glass ball, there are no guarantees with beta. The measurements rely solely on the historical movement of the stock. It does not take into account late-breaking information that could suddenly change a stock’s risk value.

Contact David Clucas at 303-440-4950 or e-mail dclucas@bcbr.com.

Calculating risk

There are several online sites can help you calculate risk. Some sites have online quizzes, which ask certain questions to determine risk. A few include:

* CNBC Investment Risk Test: www.msnbc.msn.com/id/3304753/

* Rutgers University Risk Quiz: njaes.rutgers.edu/Money/riskquiz/

* RBC Dain Rauscher Risk Quiz: www.rbcdain.com/ (search for ‘risk quiz’)

Other sites analyze the investments you already have to tell you how risky your portfolio is. A few include:

* RiskGrades.com: www.riskgrades.com

* Morningstar’s Instant X-ray Tool: www.morningstar.com (search for ‘instant x-ray’) 

* Morningstar’s Advisor Tools (free trail): advisor.morningstar.com/InstProductPages/modulecover/0,,3713-pm,00.html