Using RiskMetrics to Measure Investment Risk - dummies

Using RiskMetrics to Measure Investment Risk

By Russell Wild

An outfit called RiskMetrics offers a new, easier way of comparing investment risk. Instead of using standard deviation (the most common way of measuring risk), the folks at RiskMetrics have come up with a scale that allows for a much simpler understanding of risk.

Check out the RiskMetrics tool on the Nasdaq website. Plug in any of the various bond (or stock or commodity) exchange-traded fund symbols, and voilà, you are given a number. The higher the number you receive, the greater the risk. The lower the number, the lesser the risk.

Unlike standard deviation numbers, RiskGrade numbers are logical and to scale (just like the metric system of measuring distance or weight). In other words, an investment with a RiskGrade of 20 is twice as volatile as an investment with a RiskGrade of 10, and half as volatile as an investment with a RiskGrade of 40.

Unfortunately, because mutual funds don’t trade on exchanges such as the NASDAQ but exchange-traded funds do, this nifty tool doesn’t work for mutual funds — only for ETFs. But many mutual fund companies can provide you with RiskGrade numbers. The free tool on the NASDAQ site allows you to compare and contrast any of the dozens upon dozens of bond ETFs, including those in this table.

RiskGrades takes into consideration various kinds of risk, including interest rate risk, currency fluctuation, and default risk. Theoretically, at least, the RiskGrades methodology could prove to be a truer measure of future risk than the always backwards-looking standard deviation. You may wish to compare and contrast the two measures, and take them both into consideration when choosing a bond fund.

Name of Fund Type of Bonds in Fund RiskGrade
iShares Barclays 20+ Year Treasury Bond (TLT) U.S. government bonds with very long maturities 100
iShares JPMorgan USD Emerging Markets Bond Fund (EMB) Emerging-market bonds, dollar denominated 36
iShares S&P National AMT-Free Muni Bond (MUB) Intermediate-term municipal bonds 27
iShares Barclays Agency Bond Fund (AGZ) Government agency bonds 14
Vanguard Short-Term Corporate Bond Index (VCSH) Investment-grade corporate bonds with short maturities 11