Assessing your nerve for risky investments; Testing: In sizing up a customer, some brokerages test the client's tolerance for risky investments.; DOLLARS & SENSE


You're in the hardware super store and the last bag of grass seed is 25 feet up on the top shelf. You could leave it there and go home empty-handed, you could wander around looking for a sales clerk, or you could make like Spiderman and climb up and get your Kentucky 31.

In investment terms, that's a risk-and-return problem. How likely you are to risk your neck to get what you want is a calculation you have to make before putting together an investment strategy.

"Assessing a client's tolerance for risk is one of the primary things you have to go on," said Richard W. Stevens, a personal financial services principal for the Vanguard Group in Pennsylvania. "The problem with it is it's not an exact science. It's a little bit of an art. It's one of the toughest pieces of financial planning."

Different investors face different types of risk, and every individual will react to risk in a unique way. Age, prior investment experience, individual outlook -- a whole range of factors contribute.

The trick these days is that the prolonged rapture of the stock market has made many investors forget how real risk can be.

"People are spoiled," said Deborah Voso, a certified financial planner and president of Voso Associates in Frederick. "Everybody knows that stocks have risks inherent with them, however people seem to be forgetting that over the last few years."

Stocks are not the only financial instrument that carry risks, of course. Voso said that anyone working on a personal strategy must keep in mind a host of trade-offs.

Keeping your funds in cash -- through a savings account, certificate of deposit, money market fund or the like -- might protect against loss, but the rate of return can be very low. And if the return is lower than the rate of inflation, you wind up losing money after all. What's more, you'll probably have to pay taxes on any gain.

Bonds offer better return, but still can carry an inflation risk. And if interest rates go up just when you want to sell, it's going to be hard to find someone who wants to buy a bond that runs less than market rates.

The solution is often to carry a mix of investments, and it is each individual's tolerance for risk that helps determine what kind of mix is appropriate.

Voso asks her clients a series of questions to create a risk profile. For instance:

What is the purpose of this money? Is it for a short-term use such as buying a new house in two years, or is it long-term, such as saving for college or retirement?

What is your need for the money: income or growth?

What experience have you had with the market -- good, bad or none?

If your portfolio went down 10 percent, how would you feel?

"If they said 'panicked' to that last question, you have to listen to how they answer it," Voso said. "Sometimes it just means they have to be educated, sometimes it means they shouldn't be in the market."

Many brokerages offer self-tests that investors can take to get an idea whether they stand closer to the Beach Boys or to the Beastie Boys on the risk tolerance scale.

Vanguard has one on its Web site, for instance -- though Stevens warned that a self-test is only a start. "Most people rate themselves as moderate risk-takers. The real benefit is taking that next step and working with a planner [who will] hammer that out with them and start to get more exact."

One way to "put some reality" into the business of risk-profiling, Stevens said, is to cook up some sample portfolios and look at how they would have performed.

"If you can show that [a particular portfolio] would have spent 80 percent of the time in a certain range, you can start to make it more of a science," he said.

Once the parameters of a particular plan become clear, other factors come into play. Age is one of the most basic influences on an investor's approach to risk.

Traditionally, growing older has meant pruning risk out of the portfolio. Conventional wisdom said that any investor who thinks the big closing bell in the sky is going to ring soon will want to stay away from short-term losses.

But the rules are changing. People are living longer, and stocks have performed too strongly to resist.

"What if you were 59 years old and about ready to retire -- does that mean no stocks at all? The answer is no. How long are you going to live in retirement? Twenty-five years? That's a long time to live with no growth," Voso said.

In fact, a 1997 study commissioned by the Association for Financial Counseling and Planning Education found that risk tolerance actually increases with age as people accumulate more resources and worry less about the distant future.

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