Some risks are necessary, some aren't Investor can create opportunity for misery

Mutual Funds

January 25, 1998|By Jeff Brown | Jeff Brown,KNIGHT RIDDER/TRIBUNE

Investing involves risk. We all know that, don't we?

Sure, but after years of a galloping bull market, it's easy to shrug off the risks, pointing to the long-term performance that has made stocks big winners for people who stick out the downturns. Still, now that the market has become so volatile, it's worth reviewing all the types of risks we face.

To this end, the Forum for Investor Advice, a nonprofit outfit set up by 70 fund companies, brokerages, banks and insurers, recently listed key investment risks:

Economic risk -- when the economy slows, recession threatens and falling company earnings drag down stock prices.

Market risk -- when emotion and the herd mentality drive stocks unreasonably high, setting latecomers up for a fall, or unreasonably low, causing losses for anyone who can't wait for a rebound.

Industry risk -- when an industry is struggling while the economy overall is healthy. Your challenge: Is this industry a dog or a bargain?

Company risk -- when a company has problems while its industry or the economy in general are strong.

Credit risk -- when a bond issuer may be unable to pay interest or repay principal as promised.

Interest rate risk -- when interest rates rise, causing bonds to fall in price.

Not mentioned in the Forum's list, but relevant today, is currency risk -- when a strengthening dollar undermines values of foreign investments.

The simplest way to deal with most kinds of risk is to diversify -- to spread your money around so that one kind of bad luck can't torpedo your whole portfolio.

Even something as broad as economic risk can be reduced if you own investments in foreign stocks and keep some money in bonds and cash. Credit risk is not too high if your bond investments are spread among various issuers with high credit ratings. And interest rate risk is reduced if you own bonds of various maturities. Also, time can reduce the damage of any kind of risk whose effects are temporary. The economy has always emerged from recessions. Many battered industries and companies recover. Interest rates often fall after rising.

There also are risks that investors create themselves:

Rearview mirror risk -- when an investor looks at the past performance of a stock or fund and figures it just has to repeat itself. There's a big difference between an investment that's really a high flier and one that's merely volatile.

Cocktail party risk -- when an investor acts on a hot tip from a loudmouth planted by the bar.

Lazybones risk -- when an investor figures no one can reasonably be expected to read all those prospectuses, annual reports and proxy statements.

Great clockmaker risk -- when the investor does his homework at the start, then leaves things to run themselves.

Uncle Sam risk -- refusing to go out a winner and take profits because you just can't stomach giving the IRS its share.

I'm-a-whiz risk -- when an investor just can't believe he did something so dumb, can't admit a loser is a loser. Waiting for a donkey to turn into a racehorse means sitting out the race.

Columbus syndrome risk -- when an investor figures that if he just discovered it, it's got to be new. Nope. Millions of other people were there already.

Pub Date: 1/25/98

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