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Take time to evaluate the risks of investments


No pain, no gain. That's how some athletes talk themselves into running another mile, lifting a few more pounds or swimming a couple of extra laps.

People selling investments would say: No risk, no reward. Yes, stocks do provide more growth and inflation protection over the long run. But do stockbrokers, financial advisers and other people pushing financial products do a good enough job explaining the potential risks, as well as the possible rewards?

That's a valid question as mutual funds, brokerages and other firms keep turning out "alternatives" to low-yielding bank certificates of deposit. Last month, for instance, the Permanent Portfolio, a fund company in Austin, Texas, introduced a product called the Versatile Bond Portfolio. The press kit for the short-term corporate bond fund described it -- as many press kits do -- as a "new alternative to money market funds and CDs."

Without judging the merits of this claim, it should be noted that any investment holds some risk, and if the risks aren't explained well enough that you're comfortable, you should not make the investment.

To some people, risk is a synonym for volatility, based on the presumption that the value of an investment may go up and down over a few months or years but will go up in the long run. But to people moving out of CDs, a more useful measure of risk jTC simply tells them their chances of losing money. Many of them have already learned about this aspect of risk -- the hard way.

"We get people in here after they've been burned," says John Everets, a principal with T.O. Richardson Co., a money-management business in Hartford, Conn. "Somebody sold them a bond fund, and they thought it was safe. Instead, they actually lost principal."

This could happen to more people in the coming months if, as many economists think, short-term interest rates begin to rise, which would shrink the value of bonds and bond funds sold as alternatives to CDs. Also, with a new round of "calls," or early redemptions of municipal bonds, expected this summer, their once-attractive tax-free yields may disappear.

One reason people are sold investments with risks they don't understand is that they don't bother checking out the investment or the person selling it. Among other things, that kind behavior can lead to theft, a risk not usually mentioned in the investing books.

Most risks, however, are simpler. You make money or you lose it; your money grows enough to keep up with inflation or it doesn't. There are no purely "risk-free" investments, but Treasury bills are as close as you can get to that status, says James Stone, president of Plymouth Rock Assurance Co. in Boston and a former chairman of the Commodities Futures Trading Commission.

Short of an invasion from Mars, a nuclear war or a complete collapse of the U.S. economic system, Mr. Stone says, the interest and principal on Treasury bills represents a "riskless" investment.

Although it is possible to argue that the yield on these securities might not keep up with inflation or with an individual's rising cost of living, "that misses the point of risk" because doing anything to achieve a higher return involves taking on some additional risk, he says.

"Anything you might do to cure that problem would give you more risk rather than less," he notes.

This does not mean that all investors should park all their money in Treasury bills, he adds. It just means they have to ask themselves which risks they are most concerned about, then build an investment portfolio that addresses those concerns.

For example, investors concerned about both income and inflation might have a mix of Treasury securities and stocks. In "Wealth: An Owner's Manual, A Sensible, Steady, Sure Course to Becoming and Staying Rich" (Harper Business; $20), Michael Stolper, an investment adviser in San Diego, writes that there are only two investments people really need: Treasury bills and notes to produce income to live on, and common stocks for income and growth.

Then, it is simply a matter of finding the right allocation and maturities of Treasuries, and the proper diversification of stocks. For most people, this diversification can be achieved with a few mutual funds.

In dealing with a broker or financial adviser, it's important to listen to their claims about particular investments. If the adviser says something is "relatively safe," a former broker suggests, you should ask "relative to what?" Any comparisons on this score should be made with similar investments. Thus, the risks of a real estate investment trust should not be compared to those of Treasury bills, CDs or anything but other REITs.

Mutual funds, even no-load funds sold directly to the public, can also give misleading impressions with regard to risk. Some, for instance, also misuse independent rating systems, such as the star ratings from Morningstar Mutual Funds, a Chicago research firm. If Morningstar gives a fund five stars, it is considered less risky than one getting three stars.

But Morningstar publisher Don Phillips notes that the stars are used only to compare funds in the same class. "For instance, a below-average-risk equity fund may carry more risk than a high-risk municipal bond fund," he says.

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