Understand what "risk" means: that your investment might not make you money; or, that you could lose your initial investment, or some of the money it had previously made for you.
How much risk can you stomach? For those with little risk tolerance, money-market mutual funds offer far better returns than savings accounts or bank money-market deposit accounts. Move to equity funds, and the risk meter starts to rise. Balanced, flexible and asset-allocation funds are considered among the least risky because they invest in both stocks and bonds. Single-country, specialty and sector funds, such as Internet-only funds, are considered the most risky, because they invest in specific industries or regions of the world, and when the region or industry falls out of favor, so falls fund performance.
"Bear Essentials: What to Do During Market Declines" is a brochure from The Forum for Investor Advice, a Bethesda, Maryland, nonprofit organization, that looks at market volatility and how to plan portfolios accordingly. Here are some highlights:
- Dow Jones Industrial Average (DJIA) declines of 15 percent or more typically occur about once every two years.
- On average, during the 20th century, the DJIA declined 5 percent or more three times each year.
- It can take months or years for the DJIA to recoup setbacks. The 1929 crash took 16 years. The 1987 crash took 23 months.
- Finally, and most important, diversified portfolios can cushion the blow of a bear market. In the bear market of 1973 to 1974, stock-only portfolios lost an average of 48 percent of their values. Portfolios of 60 percent stocks and 40 percent bonds lost an average of 29 percent.
The trick to becoming a satisfied, long-term mutual-fund investor is knowing how much risk you can comfortably take. Don't let market volatility scare you-use it as a way to gauge the mutual funds to which you're best-suited.