What would you do with your money if you had a high tolerance for risk?

BY busadmin  October 10, 2008 at 3:51 PM EDT

Money; File photo

Question/Comment: If you had a high tolerance for risk, and you had a mutual fund, which you purchased in one lump sum, and it was down 33 percent, would you put more money into it to make it more like you had dollar/cost averaged?

Paul Solman: If you really have a high tolerance for risk and the money to do it and no immediate need for that money, sure.

Many readers won’t know what you mean by dollar/cost averaging, so let me explain briefly: it’s buying gradually, over a stretch of time, so that your cost reflects the “average” price of what you’re buying (over that period). By contrast, if you bought at any ONE point, THAT would be your cost and it might well be that you bought at an all-time high. (Or, admittedly, an all-time low.)

The one thing you can be sure of right now is NOT buying at an all-time high, however. So if you can stomach the risk …

Let me tell you a short story. In August of 1998, I moderated a NewsHour segment on the Russian market crisis of that year. Here’s an excerpt that may seem eerily relevant to today:

PAUL SOLMAN: …I happen to have put $3,000 in a Russian mutual fund two years ago. I called up today in preparation for this. It’s now worth $603.10. Did somebody take my money? I mean, what happened to it?

JOHN CAMPBELL [Harvard finance economist]: Well, what happened is that, you know, that price reflects the best assessments that investors collectively can make of the value of your investment, of the underlying assets. And you might ask where did that go?

PAUL SOLMAN: That’s what I am asking.

JOHN CAMPBELL: The reason is that assets don’t have value in themselves. They have value for how they’re used and the profits that they can produce, and if an economy turns sour and the capital is not being well used, as for example it clearly isn’t in Russia, then that value can disappear very quickly.

RICHARD MEDLEY [Wall St. consultant]: But I think the short answer is really that it has — it’s vanished; it’s disappeared. And that’s-as Professor Campbell said-that’s one of the major problems we’re facing is all of a sudden about a trillion dollars in world GDP has disappeared. It no longer exists. Mr. X doesn’t have it. Mr. Y doesn’t have it. No one has it.

PAUL SOLMAN: So this all boils down, then, Mr. Medley, to a question of confidence in the world economy and expectations about the future, and the minute that turns, then suddenly everything is worth less?

RICHARD MEDLEY: Well, it did boil down to a matter of companies. Now you’ve really got real economic consequences and real financial damage. I mean, when Russia declared essential default the other day, all of a sudden big market players like Credit Suisse, First Boston, had to mark those positions to market, they had to say now we have to admit these things are worth a lot less than we thought they were, and it-

PAUL SOLMAN: These things meaning the bonds that they were holding.

RICHARD MEDLEY: The stocks, the bonds-

PAUL SOLMAN: Or the stocks.

RICHARD MEDLEY: Everything they were holding now are worth so much less we have to say to our stockholders, we’re going to take a big hit at the end of this quarter, and institution after institution is going through that, and investors are turning around, like you did today, and saying, wait a minute, $600, well, I’d better take that $600 while I still have it—

PAUL SOLMAN: No, I didn’t do that.

RICHARD MEDLEY: —and put it somewhere where I can be safe, which is why you’ve seen Americans bonds and German bonds rise so sharply in price and interest rates fall so quickly over the past few days.

PAUL SOLMAN: No. I can just imagine, though, if I were a Russian and I had $3,000 two years ago and I had $600 today, I’d just be in utter despair.

RICHARD MEDLEY: You’d have about $200 today, but, yes.

The point is I didn’t sell, in part, because I didn’t really consider the money mine. It was being saved to give to charity in Russia, which wasn’t an easy thing to do (safely) in 1998. So I’d put it in the Russian market as an infinitesimal boost to that economy and kept it in for the same reason. And waited.

Sure enough, in just a few years the market turned around. The ruble strengthened. And when I sold and gave the money away, it was worth $3,400. (I’d finally found a way to transfer money without fear it would get skimmed.)

But the Russian market was on its way — to $5,000 a year or so after I sold. Lord knows what my stocks would have climbed to by 2007, say; surely many multiples of the original amount.

I’ve often thought, over the years, of the question you pose: why didn’t I buy another $3,000’s worth when my mutual fund shares had dropped to $200? Why didn’t I put in bits of money, little by little (dollar/cost averaging)? Why didn’t I wait before selling? As it turned out, an orphanage in the countryside got all-new beds. But had I waited, I might have been able to fund an entire new facility.

The American economy is not going to be down-and-out forever. So why not double down now? Or dollar/cost average? Because you might not sleep a wink if you did and the market continued to plunge. Remember my Russia numbers: $3,000 to $200, if Richard Medley was right. That would equate to a Dow of about 1,000 right now.

On the other hand, if you’ll sleep as well as ever and don’t need the money for years, you have stated a very good reason to go for it: a 33 percent discount from the peak.*

*- I wrote the above this morning. Make that a 36 percent discount. As of 2:26 pm EST