Do Your Investments Match Your Risk Tolerance?
When was the last time you looked at the contents of your portfolio?
Provided by Gardey Financial Advisors
It is a good idea, from time to time to review how your portfolio assets are allocated, in other words how they are divided among asset classes or diversified.
At the inception of your investment strategy, your target asset allocations reflect your tolerance for risk. Over time though, your portfolio may need adjustments to maintain those target allocations.
Since the financial markets are dynamic, the different investments in your portfolio will gain or lose value as different asset classes have good or bad years. When stocks outperform more conservative asset classes, the portion of your portfolio invested in equities grows more than the other portions.
To put it another way, the passage of time and the performance of the markets may subtly and slowly cause your portfolio asset allocation to drift away from your target asset allocation.
If too large a percentage of your portfolio has drifted away from your target asset allocation you may be taking on more or less risk than you intended. To address this, your portfolio can/should be brought back in alignment with your target asset allocation. This process is called rebalancing.
A balanced portfolio is important. It would not be if one investment class always outperformed another – but in the ever-changing financial markets, there is no “always.” In certain market climates, investments with little or no correlation to the stock market become appealing. Some investors choose to maintain a significant cash position at all times, no matter how stocks fare.
Downside risk (the possibility of investments losing value) can particularly sting investors who are overly invested in momentum/expensive stocks. Historically, the average price/earnings (P/E) ratio of the stock market as measured by the S&P 500 has been approximately 14 times greater than their combined weighted average earnings. A stock with a dramatically higher P/E ratio may be particularly susceptible to downside risk. 1
Underdiversification risk can also prove to be an Achilles heel. As a hypothetical example of this, say a retiree or pre-retiree invests too heavily in seven or eight stocks, if shares of even one of these firms plummet, that investor’s portfolio may be greatly impacted.
Are you retired or retiring soon? If so, this is all the more reason to review and possibly adjust the investment mix in your portfolio. Consistent income and the growth of your invested assets will be among your priorities, and therein lies the appeal of a balanced investment approach, with the twin goals of managing risk and encouraging an adequate return.
Risk Tolerance is a crucial part of portfolio construction and in achieving a client’s financial goals. If you have questions or concerns about your risk tolerance or the level of risk your portfolio is taking, please contact your financial professional.