Financial News & TipsAlan S. Moore / L’Observateur / November 2, 1999Successful investing usually means taking more risk for a potentially higher return. However, risky investments such as those high-flyingInternet stocks may not suit many conservative investors. In addition,reducing portfolio risk may now be prudent as some financial experts warn of an overvalued stock market that is due for a correction. If youworry that by selling stocks you risk missing out on another market surge, there are other ways to reduce your overall portfolio risk than jumping in and out of stocks.
Published 12:00 am Tuesday, November 2, 1999
Time Heals All Wounds
Buy low. Sell high. Sounds simple. But whether the market is roaring aheador seemingly in an endless downward spiral, in the long run it pays off to resist the temptation to try to predict its short-term direction. Time, nottiming, helps to reduce risk and patience has rewarded long-term investors. Short-term investors face a statistically greater risk of losingmoney than long-term investors who have more time to ride out any dips in the market.
So, while you shouldn’t invest in high-risk securities if you’re going to need the money within the next few years, you can take more risk with money you won’t need for several years. Say you have a son age 10 and adaughter age 19. You want to invest for your son’s college education andfor your daughter’s wedding in two years. Since your son won’t be startingcollege for another eight years, you generally can afford to take more risk with his education portfolio than with your daughter’s wedding fund.
Measuring Risk
There are several methods of measuring an investment’s risk. One of themost commonly used is standard deviation, which illustrates an investment’s volatility by measuring the variability of its actual returns from its average return over a particular time period.
An investment’s beta is a measure of its relative risk versus an index of the market as a whole. For stocks, beta might be measured against theStandard & Poor’s 500 Stock Index. A stock with a beta of one would havethe same volatility as the S&P 500. A beta of more than one means thesecurity is more volatile than the market and a beta of less than one means it is less volatile than the overall market.
Diversify Diversify Diversify
You can also reduce portfolio risk by diversifying among different asset types. You don’t need complicated models to use diversification. Simplydividing your money into investment types that tend to move in different directions in different market conditions can reduce overall portfolio volatility.
While it may be tempting to try to time market moves, the best antidote for portfolio risk is time and diversification.
(Alan S. Moore is a financial advisor of Legg Mason Wood Walker, Inc., adiversified securities brokerage and financial services firm that is a member of the New York Stock Exchange, Inc. and SIPC.)
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