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Risk Level Index

(MAXfunds.com) -- To learn one of the single most potent and valuable lessons of successful investing, all you have to do is answer the following question correctly: Which is better, gardening or skydiving?

Before you answer be sure to read the question carefully. Notice I'm not asking you which activity you like better, or which one you would enjoy spending a Saturday afternoon doing more. The question is which one is better -- intrinsically, inherently, essentially, fundamentally, just plain better -- gardening or skydiving.

Not sure? Here's a quick rundown of each to help you make up your mind: Gardening is meditative and rewarding. A good gardener can grow beautiful flowers and juicy tomatoes and herbs. Gardeners feel that they are more in touch with the earth, and take great pleasure in watching what they've planted grow.

Skydiving is incredibly exciting (or supposedly so, I've never done it). Skydivers become addicted to the adrenal rush of plummeting to earth at 140 miles an hour from heights of 14,000 feet. Skydivers say that the inherent danger of skydiving makes them feel more alive.

Still stumped? Good. Because the answer to the question above is, of course, neither activity is 'better' -- they're just 'different'.

Many gardeners would never dream of willingly subjecting themselves to the terrors of skydiving, while many skydivers can't comprehend why anyone would want to spend entire days doing something as boring as watching plants grow.

Risk, as it applies to investing in general and mutual funds in particular, is the same thing. A 'safe' mutual fund isn't better than a 'risky' mutual fund -- just different.

Some mutual funds, like balanced or utility funds, are considered low risk because they are not very volatile. Some, like technology and emerging markets funds are considered high risk because they tend to be more volatile. Which type of fund is better for you depends on your particular situation and time horizon.

The trick is building a portfolio of funds that has a risk level appropriate for your risk tolerance.

If you invest in a low-risk balanced fund you can expect low volatility -- the fund probably wont go up more than 7% in a good year, but it shouldn't drop much more than that in a bad year, either. You're not exposing your investment to very much risk, so you can't expect to make a lot of money on your investment.

Money invested in an emerging market fund is exposed to a great deal more risk. If you invest in a Russia fund, for instance, and Russia defaults on its international loans or devalues the rouble, the fund could drop 70% in a month. Because you're exposing your money to the possibility of a big loss you expect the potential upside of the investment to be roughly as large as the potential downside.

But just because a high-risk fund isn't inherently better or worse than a low-risk fund doesn't mean that one or the other isn't a better investment choice for you.

Which type of fund is better depends on who it is that's doing the investing.

If you're a person nearing retirement age, you'd probably want to invest in low-risk funds because your investment time horizon is short and you may not have the time to recover from a bad year.

If you're a kid just out of college, you have the risk tolerance to invest in more aggressive funds. If your portfolio drops 15% next year, who cares? You got 40 more years of investing to make up the loss.

Building a fund portfolio that matches your risk profile is just about the single most important thing an investor can do to help meet investment goals. Unfortunately fund companies are notorious for understating their fund's risk levels to potential investors in prospectus, ads, and literature.

To find an unbiased assessment of a fund's risk level check it's Fund analysis page on MAXfunds.com (it's on the left side, at the bottom of the MAXmetrics column.)

We express each fund's risk level expressed as a number from 1 through 5. A fund with a 1 rating is about as safe as equity investing gets, with the likelihood of losing more than 10% being pretty remote. A fund with a 5 rating is very risky, with loses and gains of over 40% being relatively common.

But even if you don't get your fund's risk level information from us, be sure to get it from somewhere -- the last thing in the world you want to do is invest in funds that are too risky (or not risky enough) for your investment goals

(c) 2001 MAXfunds.com

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