Naked Truth Investing: Would you go to a heart doctor who couldn't identify the aortic valve?
I am sure you wouldn't entrust your health to a medical professional who didn't have a complete knowledge of her area of expertise.
Yet millions of investors rely on "investment professionals" who can't define risk, much less measure it. If you don't know the risk of your portfolio, you can't invest intelligently for retirement.
Long term returns are determined by your asset allocation. Your asset allocation is a function of your capacity for risk. How do you determine your risk capacity?
Take an asset allocation questionnaire. There are many of them on the internet, Or you can find one on my web site.
Compare the asset allocation indicated by the questionnaire to your present asset allocation. If they are not comparable, consider changing it.
Next, find out the risk of your current portfolio. This is the tricky part. Start by asking your "investment professional" how she measures risk (let's give her the benefit of the doubt and assume she actually does measure risk. Most brokers and advisers in my experience don't).
There is only one right answer to this question: standard deviation. Standard deviation is a statistical measurement of the historical volatility of your portfolio. Ask her to compute your three-year standard deviation.
For conservative investors, the standard deviation should be no more than 8%. For very aggressive investors it should be no more than 20%.
If you can't get your standard deviation, assume your broker has a sign around her neck reading "I am incompetent."
Dan Solin is the author of The Smartest Investment Book You'll Ever Read (Perigee Books 2006) and The Smartest 401(k) Book You'll Ever Read (Perigee Books, June 24, 2008). Visit his website at Smartestinvestmentbook.com.