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Educational Programming Video

The Value Line Mutual Fund Survey
Program 16: Financial Planning Part 5

In this session, we'll continue our discussion about financial planning, specifically risk.

For many investors, determining risk tolerance levels is one of the most difficult tasks when creating a financial plan. To help you get a handle on this, read the following statements and decide which ones best fit your personality. After the first few, you will have a better idea of where you fall on the risk/risk-aversion spectrum.

  • "One can't be too careful."
  • "When in doubt, err on the side of caution."
  • "Nothing ventured, nothing gained."

    How about:

  • "Put safety first."
  • "Don't put all your eggs in just a few baskets. Diversification is very important."
  • And "Go with your strong suit. Emphasize your strengths. Put most of your money into your best investment ideas."

    Now these:

  • "If you save for a rainy day, you'll never get wet."
  • "I need to begin thinking about the future."
  • "Live for today. The future will take care of itself."

    Each of these statement groups started with the most conservative thoughts first and the most aggressive last. If you found yourself agreeing with the first statements, you are a conservative investor. If you found yourself agreeing with the second statement in each group, you are willing to take some moderate, controlled risks. Investors that associated themselves with the last statements are the real daredevils.

    Now read the following questions and select the answers that best fit you.

    If someone whose opinion you respect told you the time was right to risk the loss of more of your assets in order to have the potential to realize substantially higher returns. You would:

  • refuse to take any more risk.
  • increase your risk a little bit.
  • increase your risk by a substantial amount.

    Now this one: you can make an investment in a new type of zero coupon bond that will pay 20 times your initial investment in 10 years if the issuing company survives. The minimum investment is $10,000. You have determined that the company has a 70% chance of surviving that long. That gives you a 30% chance of losing your entire investment. You would:

  • not invest in this risky proposition.
  • invest $10,000.
  • invest $20,000 or more.

    Once again, the least aggressive statements were first and the most aggressive were last. If you lean toward the first statements you're conservative, the middle statements you are moderate, and if you favor the last statements you're a risk taker.

    A more detailed investor quiz can be found in The How to Invest in Mutual Funds guide. But these few questions can give you a handle on what type of investor you are: conservative, moderate, or aggressive.

    Now that you know this, you can start to think about creating an asset allocation framework. Asset allocation, at its simplest, means diversification of financial investments among stocks, bonds, and cash. At a more sophisticated level, asset allocation involves trying to squeeze the greatest potential return out of a given level of risk.

    Given a choice between assets, an investor stands to realize the greatest return by choosing, to the exclusion of all others, the asset expected to perform best. Diversification automatically dilutes the potential return. But because some assets typically rise when others fall, it is possible to diversify among asset classes in such a way as to lower the potential risk by a greater amount than one has lowered the potential return. This concept of portfolio optimization captures the essence of what all investors are trying to accomplish: getting the highest potential return within the limits of acceptable risk.

    Differences of opinion abound concerning how to determine the percentage of assets that should be invested in stocks, bonds, and cash, respectively. Perhaps the simplest rule of thumb is this: The percentage of assets in bonds and cash combined should equal the investor's age. The remainder should be in common stocks.

    This oversimplification is intended only to illustrate the conventional wisdom: A young investor seeks growth, primarily through stocks, while an older investor requires stability and the income generated by a larger percentage of assets in bonds and cash. Clearly, individual preferences and circumstances must be the determining factors in making asset allocation decisions. No matter what you do, you need to be able to sleep at night.

    By varying exposure to different asset classes, investors can create and modify their portfolios to obtain the exact risk/reward profile that meets their financial goals. So, next session, we'll discuss the different types of asset classes and how they interact.

    Factual material is obtained from sources believed to be reliable, but the publisher is not responsible for any errors or omissions, or for the results of actions taken based on information contained herein. Nothing herein should be construed as an offer to buy or sell securities or to give individual investment advice. © 2018 Value Line Publishing, Inc. RIGHTS OF REPRODUCTION AND DISTRIBUTION ARE RESERVED TO THE PUBLISHER. The Publisher does not give investment advice or act as an investment adviser. Value Line, Inc., its subsidiaries, its parent corporation and its subsidiaries, and their officers, directors or employees as well as certain investment companies or investment advisory accounts for which Value Line, Inc. acts as investment advisor, may own stocks that are mentioned on this Value Line Web site.