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Evaluating Investment Risk

To strike a balance between an investment’s risk and return, you must first be able to evaluate risk. But there is no one simple way to measure risk, which comes in many shapes and forms.

Volatility, the tendency of an investment to fluctuate in value, represents a significant risk in many investments, may be gauged in several different ways. Standard deviation and beta measure an investment’s volatility relative to an index or peer group. Two other measurements, largest monthly loss and downmarket performance, look at the stock or fund’s downside risk. And the Sharpe ratio seeks to measure the relative reward associated with holding risky investments.

Investors seeking to reduce risk should first assess their risk tolerance based upon their goals, financial condition, time frames, and comfort levels. Then there are some simple tools that can help lower risk: portfolio diversification, which lowers exposure to one area and seeks to offset potential losses in one asset class with gains in another; and dollar-cost averaging, which can help reduce market timing risk through regular investment of fixed dollar amounts over a sustained period of time.

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