Home' Trinidad and Tobago Guardian : March 20th 2014 Contents The issue of managing the risks
associated with investing is
quite topical at this time. Not
only has it been referenced in
this space over the past couple
weeks, but it is also a factor
given the run up in the local and US stock
markets, the very low interest rate environment
and some of the geopolitical tensions that
This week I will seek to give a basic insight
into how risk is measured as well as providing
some guidance into assessing your tolerance
to risk. Appreciate that this is all rudimentary
and not a substitute for a discussion with an
investment professional, but it will give you
an idea of how the process can unfold.
Having a basic understanding of investment
risk is essential to making good investment
decisions. More importantly, there are lots of
people who attempt to invest, but have not
quite grasped the concept of risk and how it
impacts on their investments. Further, the
market is changing so rapidly that we are now
witnessing occurrences that are unique.
At a basic level, risk is measurable and this
is done by calculating the volatility of returns
or price for a stock (bond or any other asset).
The most common measure of risk is the stan-
dard deviation of returns. However, instead
of going into the details of how this is calculated
you might better appreciate the concept via
Let's take two hypothetical companies, Steel-
yard Ltd and Calypso Ltd. You paid $11.65 a
share for steelband a year ago and, at the same
time ,$15.00 a share for calypso. The table
shows their share prices at the end of each
month. See table
Both stocks earned a rate of return of 20
per cent for the year (rounded to the nearest
whole number). On the face of it, you will
probably think that it did not matter which
company's share you held in your portfolio.
A closer look at the table reveals that Steel-
band's share price was more volatile than
Calypso's. From the math, the standard devi-
ation of Steelband's stock was $3.02 or 21 per
cent of the average month-end share price of
$14.58. Calypso's share price had a monthly
standard deviation of $2.77. This was only 16
per cent of its average month end share price
While the returns at the end of the year
were the same, the volatility of the share prices
of the respective stocks can make a huge dif-
ference, not only to your portfolio return, but
also to your psychology as an investor.
People generally don't like to see the value
of their assets fall and, as a result, a more
volatile stock can bring you more "stress",
even if the returns are the same at the end
point. Without getting too complicated, you
should note that it is not just the return that
matters, but the risk adjusted return. In other
words, what level of return you are getting for
the risk you are taking.
Risk and return are related. Greater risk
should result in a greater rate of return and
vice versa. This is called the risk-return trade-
off. In the above example, both companies
generate the same annual return of 20 per
cent, but it was decidedly less risky to invest
in Calypso than in Steelband. Calypso was,
therefore, the more "valued" investment
because it carried a lower risk/return profile
The example applies to all assets not just
shares in the stock market. Your property
investment may be going up and down in
value over time. It's just that because a price
is not quoted daily you do not appreciate it.
You can categorise almost any class of assets
by the degree of risk. Stocks have historically
been riskier (in terms of volatility) than bonds
and bonds riskier than cash. In addition, within
each asset class (for example, companies listed
on the stock market), some investments are
riskier are others. It is therefore imperative
you understand the risks associated with the
companies that you are investing in.
Among those investments with the least
degree of risk are balanced mutual funds,
money market accounts and cash deposits
which are insured with the Deposit Insurance
Investing in a government-backed instru-
ment, such as treasury bills and bonds, are
considered among the safest of all investments.
However, they also offer the lowest comparative
Your tolerance to risk
Understanding the risks associated with
investing is one part, but as I alluded to earlier,
recognising how it impacts on your thinking
is also key to the investment equation. Each
individual investor should take the time to
assess their tolerance to risk. Your risk tolerance
is an approximate measure of your willingness
to accept investment risk. If you have a high
risk tolerance, you're more likely to accept the
risk of losing some of your investment in
exchange for the chance to earn a higher rate
To get an idea of your risk tolerance, take
a few minutes to complete the accompanying
risk tolerance quiz. Your financial adviser would
probably offer a more detailed version. There
is much more sophistication to this process
that can be captured in a newspaper article.
If your total score is 30 or more points, this
quiz suggests you have an extremely high tol-
erance to risk. If you score between 25 and 29
points, consider yourself an aggressive investor.
If you score between 20 and 24 points, your
have a risk tolerance that is above average. If
you score between 15 and 19 points, consider
your risk tolerance to be average. This is the
range for the typical investor.
If you score fewer than 15 points, you have
a low tolerance to risk and well fewer than
ten points suggests the lowest tolerance to
risk. Appreciate that your risk tolerance influ-
ences the type of investments that comprise
your portfolio, which then has to match your
return expectations. If there is a mismatch,
then you really should seek the counsel of a
financial professional as it could be you are
being driven by fear or greed which, ultimately,
results in disillusionment.
After assessing your risk profile, the next
step is to determine if your current financial
circumstances support your risk tolerance.
You may have the appetite for risk, but may
not have the resources to satisfy this appetite.
Once you have put this together, select the
assets that you would like to have as invest-
ments in order to meet your objectives.
For specific investment advice, you should
consult a financial adviser.
Ian Narine is a broker registered with the
Securities and Exchange Commission
BG20 | COMMENTARY
BUSINESS GUARDIAN www.guardian.co.tt MARCH 2014 • WEEK THREE
Risk Tolerance Quiz
1. I plan on using the money I'm investing...
a) after 7 years or more.
b) between 3 and 6 years.
c) within the next 3 years.
d) within the next 6 months.
2. The money I routinely invest represents
what percentage of my total assets (not in-
a) Less than 25%.
b) Between 25-50%.
c) Between 50-75%.
d) Greater than 75%.
3. Over the next 5 years I would choose in-
vestments that can cause my income to....
a) ...grow quickly.
b) ...grow ahead of inflation.
c) ...grow slowly or not at all.
d) ...decline if I factor inflation.
4. Do you have emergency savings?
a) Yes more than enough.
b) Yes just about enough.
c) Yes, but less than I'd like.
5. I would feel comfortable risking ___% of
my money available for investing if the
chance of doubling it was 50%.
6. Have you ever invested in individual
stocks or stock mutual funds before?
a) Yes, and I was comfortable with it
b) No, but I look forward to it.
c) Yes, but I was uneasy with it.
d) No, and I don't want to.
7. What do you want your money to do for
a) Grow as fast as possible; current income
b) Grow faster than inflation; produce some
c) Grow slowly and provide a nice income
when I retire.
d) Preserve principle, no matter what.
Adapted from (US) Securities Industry Asso-
4 points for every (a) answer
3 points for every (b) answer
2 points for every (c) answer
1 point for every (d) answer
tolerance to risk
Links Archive March 19th 2014 March 21st 2014 Navigation Previous Page Next Page