By Steve Dinnen
Risk abounds. There’s risk in jaywalking across Ingersoll at rush hour. There’s risk climbing onto the roof to clear the gutters. And there’s risk in securities markets. Boy, is there, especially in today’s volatile economic and geopolitical climate, and that’s what interests Toby White (pictured), associate professor of finance and actuarial science at Drake University. One of his specialties is assessing risk, or risk tolerance – quite simply, the measure of how much of a loss an investor is willing to endure within their portfolio.
It’s relatively easy to define, and relatively hard to pinpoint. What exactly is the amount of risk you’re willing to accept for the payoff – the reward of a profitable investment? There’s no precise measurement, though White ticked off a number of components that go into your assessment.
Inflation, for instance. It creates risk. So does war in Ukraine, both for security and for the unsettling of commodities markets where Russia plays such an outsized role. The ongoing presence of COVID and the many supply chain issues the pandemic created are certainly components of a risk assessment. The run-up in interest rates has created risk, as has inflation. And White noted these are sudden jolts to markets – never a formula for a risk-free environment.
All of this has created volatility – and upped the risk game. “The volatility is here to stay,” said White.
People in general have differing perspectives on risk depending on age, gender and affluence. “People who are younger and just starting out are more about capital appreciation than capital preservation,” said White, and thus perhaps willing to take on more risk to achieve their goal. He noted that a number of his students at Drake are investing in cybercurrencies. Not huge amounts, perhaps, but still, they’re in a risk environment that differs greatly from buying a dividend-paying utility stock.
People with more money than those college kids might be expected to be able to handle higher risks, too. But White said that’s not always the case, since people who have a substantial amount of money may invest in a relatively conservative manner in order to preserve what they already have.
Your risk tolerance may change with life events – marriage, divorce, death in the family, etc. You are expected to have a vastly lower risk tolerance at age 75 than at age 25. All stocks, no bonds will reverse to all bonds, no stocks. But there’s no escaping risk – wherever you are.
What Is Your Personal Risk Tolerance Level?
Risk tolerance boils down to a single number; you just have to find it. Are you comfortable with a stock sliding 10% before you give up on it and sell? 15%? 3%?
I may have already shared this, but it bears repeating: Until recently, I didn’t have a formal risk “policy.” Then I was commiserating at lunch one day with John C., a friend, about how my position in USX Corp. had cratered 55%, and he gave me a better number than that – 10. “Ten percent and it’s out,” he said. Good, solid advice that would have saved me a bunch with USX.
I have three trading platforms – a taxable account, an IRA and a Roth IRA. Each has a different risk tolerance. Ten percent and out applies to taxable trades, while I’ll let a stock slide 15% in an IRA because I own stocks there that are more volatile.
The most volatile stocks – biotech startups, for instance – are in my Roth IRA and consequently carry the highest risk tolerance. But here my hope is to grab the biggest gain, which is free of taxes. It’s all about balance.