Risk Tolerance

by Jim Frye

Posted January 8, 2010

Current Observations

January Edition

Investing Success Made Simple

by Paul Sutherland

Risk Tolerance

by Jime Frye

PDF Version

What comes to mind when you think of risk? Danger? Uncertainty? Opportunity? Thrill? Risk means different things to different people, and each of us has our own comfort zone and appetite for risk. Some people are attracted to the thrill it provides, and these folks may choose to climb high mountains, drive racecars or sail solo around the world. Others, however, may view these activities as extremely dangerous and would never participate in them. The rest of us fall somewhere in between. There is risk in any situation where there is uncertainty of outcome. The level of risk a person will normally choose is best thought of as a continuum ranging from riskavoiders to risk-seekers. This is also true for tolerating financial risk.

As your financial advisers it is important for us to understand your specific risk tolerance, or the level of risk at which you are comfortable. This, along with understanding your financial goals, time horizons and risk capacity (i.e., your ability to sustain a market decline without suffering an unacceptable loss of lifestyle now or in the future) all go into ensuring that the most appropriate FIM Group investment strategy is selected for you. Said another way, risk "tolerance" addresses your emotional requirements, and all the rest is about the financial requirements for achieving your long-term goals. Often the emotional and financial requirements are aligned. At times, though, they may be at odds, such as when a higher level of financial risk is required to reach a specific financial goal. When this occurs, the alternatives to consider, either individually or in some combination, are: take on more risk, invest more, or delay or reevaluate your goals. Generally, though, we don't recommend taking on any level of risk greater than you're comfortable with, since that may lead to sleepless nights, panic or making irrational investment decisions (like selling at or near market bottoms).

Risk tolerance has been the subject of numerous research studies. It is now believed that risk tolerance is a psychological trait that can be measured and is relatively enduring. To assist with assessing a client's specific risk tolerance, FIM Group recently began utilizing a test developed by FinaMetrica, an Australian company. The test is comprised of 25 multiplechoice questions and takes about 15 minutes to complete. This is a highly respected tool and is considered to be one of the best for judging the psychological aspects of financial risk.

If you would like to complete the assessment, please contact your local office. You will receive a detailed report on the results, and a copy will also be provided to us. For couples, it is recommended that each person takes the test in order to best assess and accommodate the joint decisionmaking process.

The FinaMetrica risk assessment is not a substitute for an in-depth risk profile discussion between a client and adviser, but it does serve as a useful tool for providing an objective and more focused discussion.

We're Celebrating Our 25-year anniversary!

From the small office in Suttons Bay, to three offices and more than 30 employees, we are grateful to be a part of our clients' financial success. We have been reflecting on the last 25 years and have provided some excerpts from our newsletters through many different cycles and manias. It's reassuring that life always goes on and evolves all the while providing us with lessons and experiences.

September 3, 1987

Times are changing, and the financial markets are more volatile than I have ever experienced. Today's cycles remind me of the 1981/1982 and 1973/1974 cycles. Both of those periods proved to be transition years and times of great opportunity. Today, it looks like we are going through another cyclical change from low inflation to a higher rate of inflation. Bonds, the old bastion of safety, are getting burned by higher interest rates, stocks are at an all-time high, with gold and oil acting in concert with world tensions.

December 10, 1987

The U.S. has had eight recessions since the end of World War II, and the stock market has declined in every one of them, usually before the recession even started. Following every one of those eight recessions, the stock market has climbed to a new historic high. Naturally, we must be aware of the fact that the stock market could very well fall further, but if history repeats itself, it will surge to a new high well above the highs of a few months ago. Based upon the S&P high of 336.77 reached August 25, 1987, and today's S&P of 236.38, the market would need to go up 42% to get back to its historical high. With our "instant information" age of the '80s, the stock market crash may have already substantially discounted the next recession. I think that patient investors that carefully select stocks today and over the next twelve months or so, will be well rewarded.

January 1989

Barron's Magazine said that what made 1988 truly great "Was that it was not 1930." The Wall Street Journal titled 1988 as "A year for marking time." 1988 was a great year! Unemployment hit a fourteen-year low. Inflation was moderate. The trade deficit improved. 1988 was also a volatile year.

October 16, 1989

Computer-generated programmed trading has developed the potential to produce extremely volatile price changes in today's stock market. While this programmed trading involves no (real) investment decisions, it creates extreme volatility and affects strategies and decisions of many investors. The cancellation of United Airlines' highly leveraged takeover, combined with a tremendous wave of computergenerated sell programs, took Friday's stock market from down 30 points at 2:45 p.m. to down nearly 200 points at the close at 4:00 p.m.

May 26, 1994

The current climate of economic uncertainty, lack of leadership in Washington and other world capitals, wars and poor performance of the financial markets have combined to cloud the fact that, statistically, the United States economy is doing very well – employment is up, GNP is up, inflation is low and U.S. companies are making a lot more money this year than last. Then why are stocks and bonds down?

February 1999

Mania Madness We believe we are indeed in the midst of a market mania. In fact, there are two manias taking place in the U.S. stock market currently, large-cap index stocks and Internet stocks. The stocks, which make up the S&P 500, are currently selling at prices that are more than 32 times their earnings (the highest ratio in history), and yet their earnings are projected to grow very little if at all in 1999. At the extreme end are the Internet stocks that have little or no earnings, yet investors are willing to pay prices that assume they will continue to grow their sales and profits at their current rates for 10 years before their value catches up with today's prices! Many "investors" have abandoned all fundamental investment principles and given up on undervalued, well-managed companies with solid growth prospects and succumbed to nothing more than fad investing, otherwise known as wild speculation. Greed had driven people to "sell low and buy high" in their quest to chase what is "hot."

February 1999 – Notes from Paul

In my twenty-year career, 1998 was my most challenging, frustrating and rewarding. I had a number of "why the heck did I ever buy that" experiences when good investments with good prospects went down. Thank God for diversification. We looked very smart for our cautious posture in the summer crash but didn't fully take advantage of the buying opportunity when the markets came "roaring back" to finish with a nice gain on the year in 1998. The big Dow stocks, large technology issues and Internet stocks went from extreme overvaluation to insane and foolish prices only justified by the fact that prices were "going up."

July 15, 1999

This current market weakness is to be expected. People will continue to panic, and markets will swing wildly as always, but cycles are normal and volatility shakes out weak investors who jump ship at any price. We, as forward-looking value investors, will be waiting there to buy their bargain-priced shares. This current market weakness is where we sow the seeds for bountiful harvest of returns and profits.

July 2003 – Barry Hyman

It was just three short months ago that the U.S. stock market indexes had hit the bottom of a three-year slide. The economy was reeling, debt was rising, the Fed was pushing down interest rates to try to revive economic activity, without effect, and despite U.S. stock prices declining for three years in a row, they were still priced above their historic norms from a valuation perspective. Things looked bleak. Yet seemingly out of the blue, stocks took off and rose significantly from the early-March lows.

September 2004 – Suzanne Stepan

We are at a point in our economy when no one wants to discuss the nation's deep debt, a massive burden that may take decades for taxpayers to be free of. The war in Iraq has continued to bleed all of us, corporate profit growth has continued to slow, and low borrowing rates in the U.S. have promoted overconsumption and have acted as a counter balance to Asia's over-production.

May 2005 – Paul Sutherland

As Wall Street and corporate scandals rock investors' confidence, complacency and apathy have some frozen in the delusion that things only get better in democracies. When Enron started looking shaky, most investors dismissed the negative "noise" from journalists as "company bashing," and most other reports about the "accounting issues" were cast aside as written by people who had sour grapes about the company's success or who benefited if the stock collapsed (short sellers). Fear tends to come from lack of understanding. But if you listen to it and explore its reality, the fear will dissolve. I call this "kissing the ugly" to downsize fear.