When you watch the news on TV, the financial world can seem exciting, but it also can seem turbulent. You might have any number of reactions. Investors range from aggressive swashbucklers to more cautious financial strategists who don’t take a run at everything that comes along. Both are valid strategies, if you have the right help. In our work, it’s important for us to understand our individual client's tolerance for risk. There are certain things we can do to help you contend with the risks that every investor faces.
Whatever risks an investor might be concerned about, a good financial professional can help them find a strategy that the client will be comfortable with. And it’s something that can change over time. Maybe you feel that you’ve been too aggressive? Or not aggressive enough? Either way, we can help.
Two great strategies for managing risk are asset allocation and diversification. You have probably heard the terms “asset allocation” and “diversification” used in the same sentence, but they are very different concepts that every investor should understand.
Asset allocation refers to dividing money among different asset classes, such as stocks, bonds, and cash alternatives. These asset classes have different risk profiles and potential returns. The idea behind asset allocation is to offset any losses from one class with gains in another, thereby reducing overall risk in the portfolio (remember that asset allocation is an approach to help manage investment risk, but it does not guarantee protection from investment losses).1
On the other hand, diversification entails how your money is placed within an asset class. For example, let’s say a hypothetical stock portfolio included a computer company, a software developer, and an Internet service provider. Although the portfolio holds three companies, it may not be considered well-diversified because all the firms are connected to the technology industry. However, a hypothetical portfolio that includes a computer company, a drug manufacturer, and an oil service firm may be viewed as more diversified.1 (Again, much like asset allocation, diversification is an investment principle designed to manage risk, but it does not guarantee protection from losses.)
To some, the differences between asset allocation and diversification are subtle, but they are critical concepts to understand when building an investment portfolio.
Rebalancing is the process of restoring a portfolio to its original risk profile. A portfolio can be rebalanced in two ways. The first is to use new money. When adding money to a portfolio, allocate these new funds to assets or asset classes that have fallen. Diversification is an investment principle designed to manage risk, but it does not guarantee protection from losses. The second way to rebalance is to sell enough of the “winners” to buy more underperforming assets. Ironically, this type of rebalancing actually forces you to buy low and sell high. Periodically rebalancing your portfolio to match your desired risk tolerance is a sound practice regardless of market conditions. One approach is to set a specific time each year to schedule an appointment to review your portfolio and determine whether adjustments are appropriate.2,3
All investing involves risk and risk management is an important part of any investment strategy. Want to talk more about your risk management? Give us a call and we are happy to answer your questions.
- Investor.gov, 2021
- DDQYDJ.com, 2020
- TreasuryDirect.gov, 2020
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All investing involves risk including loss of principal. No strategy assures success or protects against loss.
Image by <a href="https://pixabay.com/users/pexels-2286921/?utm_source=link-attribution&utm_medium=referral&utm_campaign=image&utm_content=1841158">Pexels</a> from <a href="https://pixabay.com/?utm_source=link-attribution&utm_medium=referral&utm_campaign=image&utm_content=1841158">Pixabay</a>