Risk is a Fact of Life for Retirement Plan Investors

Published 12:00 am Tuesday, June 6, 2000

Alan S. Moore / L’Observateur / June 6, 2000

Risk is an unavoidable part of everyday life. Still we try to reduce our risk ina number of ways. For example, we might choose not to walk through adangerous area, we replace worn-down tires and brakes on our cars and we watch what we eat and drink. Through experience and education we learn tocontrol the risks we are exposed to on a daily basis.

It’s a different story when it comes to retirement plan investing. Manyemployees have little experience with investing and, when the first start participating in their plan, they often lack the experience they need to determine and evaluate the risks involved with their investment strategies.

The following broad overview may help you understand the different types of investment risk that can threaten your portfolio. By learning how to reducethese risks through diversification and other strategies, you can make the most of your retirement plan investments.

Market Risk – This is the risk that stock and bond prices might fall due to economic changes within the U.S. and throughout the world. Domestic andglobal political climates as well as investor expectations can also affect the prices of securities.

Interest Rate Risk – When interest rates rise, bonds and bond funds lose value. Likewise, bond prices increase when interest rates fall. This occursbecause a rise in interest rates means bonds that pay a lower rate of interest are less desirable than similar bonds paying the higher rate. Stocksand stock funds are also affected by interest rate risk. As interest ratesfall, stock prices may also be affected and stocks and bonds may offer similar returns. In this environment, investors may prefer more stable bondsto higher risk stocks.

Financial Risk – Financial risk occurs when, for example, a bond issuer gets into financial trouble and finds it hard to make interest and principal payments to bondholders. It can also occur when reports of lower earningsper share cause the price of a company’s stock to drop.

Inflation Risk – Inflation risk relates to the decline in the buying power of a dollar over time. When prices of goods and services rise, purchasing powerfalls. Cash investments that earn lower rate of return are generally mostaffected by inflation, while stocks are typically less affected because of their potential to appreciate in price at a faster rate than the inflation rate.

Currency Risk – If you own an international mutual fund, your return can increase or decrease because of changes in currency exchange rates. Forexample, when the dollar rises in value in relation to the German mark, the return on the fund with investments in the stocks of German companies is reduced when the marks are converted to U.S. dollars.Recognizing and understanding different types of risk can help you choose investments that make the most sense for your financial goals.

ALAN S. MOORE is a financial advisor of Legg Mason Wood Walker, Inc., adiversified securities brokerage and financial services firm that is a member of the New York Stock Exchange, Inc. and SIPC. He writes this column everyWednesday for L’Observateur.

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