Why Risk Management Matters 

Maintaining investments requires some understanding of the risks you take with your money. Some investments present a lower level of risk, while others could involve a significant loss of money under nonideal circumstances. If you stick only to low-risk investments, however, you might not earn as much as you could if you focused on more risky investment vehicles. On the other hand, if most of your investments carry higher risk, one or more of them could fail completely, taking your money with it. 

Success lies in creating the right balance. Diversification of the types of investments in your portfolio is key, but you should also maintain a balance of risk that works for your life, the way you want to live it. The perfect balance depends on your personal risk tolerance, proximity to retirement, and other factors. Creating a risk management strategy requires you to really investigate your goals, plans, and behaviors surrounding your investments. If you get it right, you can maximize the growth of your portfolio with less worry that it could all be gone in a few months. Follow this guide to understand how to manage investment risk and the importance of getting professional assistance in your investment planning. 

Understanding Different Types of Investment Risk 

Understanding the types of investment risk calls for an evaluation of the risks you are likely to face with a wide range of investment types. Here are a few of the most common: 

• Market Risk: When market conditions change drastically, the status of your investments could fluctuate dramatically. All investments dependent on the market face this risk, although the amount of risk depends on the investment vehicle. 
• Inflation Risk: Prices go up over time, but the payout of your investments might not. Fixed-return investments are particularly vulnerable to losing relative value as the years progress. 
• Interest-Rate Risk: The value of your investments can change due to fluctuations in interest rates. This risk primarily relates to bond investments, but could also affect real estate. 
• Credit Risk: If you loan out money, such as buying a bond that is supposed to offer regular interest payments, you run the risk that the borrower or issuer may fail to make timely payments. 
• Liquidity Risk: Your ability to cash out an investment is an assessment of liquidity. Less-liquid investments, like real estate or small-cap stocks, are more vulnerable to changes in demand, so it may be harder to get your money out at times until there’s a buyer. 
• Concentration Risk: If you have too much money in one stock or in a particular type of stock, you run the risk that market volatility could significantly drop the value of those investments and not having enough of other investments to balance that out. 
• Behavioral Risk: Your own behaviors can affect your portfolio’s performance. If you spend too much time tweaking your investments and trying to time the market, you may lose more than you gain. 

Some risks can be mitigated by diversifying your portfolio, but others are inherent to a particular industry or investment vehicle. Learning how to distinguish these risks is vital to creating an effective risk management strategy. 

Crafting Your Risk-Tolerance Profile and Time Horizon 

Your investment management plan should involve some discussion of these factors: 

• Financial Situation: How much money can you put toward investing each year, and how liquid do you need those investments to be? Assess your financial stability and large expenditures that may affect your flexibility. 
• Investment Goals: What are you hoping to get from your investments? Do you want to save for retirement, or create investment vehicles that allow you to retire early? 
• Risk Appetite: How much risk are you comfortable taking? Are you content to lose some money at times in exchange for a potential higher rate of reward? Your risk appetite will likely change as you get older and become more dependent on the returns you get from those investments, especially after retirement. 
• Time Horizon: When do you expect to collect on each investment? How long do you need to hold each investment to get a reasonable return? Most investors have a range of time horizons for various investments, with some to be cashed out within a few years and others they plan to keep through retirement. 

Portfolio Advisors uses your answers to these and other questions to construct a portfolio that aligns with your financial situation, risk tolerance, and investment goals. 

Diversification and Asset Allocation Strategies 

You’ve heard the adage not to put all your eggs in one basket. You probably know that putting all your money in one investment, like an individual stock or a real estate property, carries a much higher level of risk. If market conditions or other factors cause that asset to become incredibly popular, you could win big. If the market crashes, however, you could lose everything. 

Diversification is the solution to this problem, but you have to tailor it properly. Diversifying doesn’t just mean buying multiple stocks. It involves putting your money into different asset types in various sectors and regions. The goal is to spread out your money in a way that it can still be managed, but lowers your overall risk. With the right diversification strategy, when one investment takes a serious drawdown, the rest will hopefully lose less or perhaps even gain to balance it out. 

Efficient diversification usually involves setting a percentage of your investments that you want to be in a particular asset class, and then disciplining your portfolio to stick to it. For example, you might decide that you want to keep 70% of your money in stocks and the other 30% in bonds. If your stock values suddenly change and upset that allocation strategy, you could rebalance by selling off certain stocks or bonds to get back to your target. 

Alternative Methods of Risk Mitigation 

Although risk mitigation might seem like a delicate balance — and sometimes it is — many methods of risk management are practical for almost any investor to implement. If you want to keep your overall risk lower, you might consider the following approaches. 

• Adjust Expense Ratios: Pay attention to the expense ratios for each of your investments. Even amounts that seem like low percentages can cut significantly into your returns over many years. Choosing investments with lower expense ratios can help you increase your rate of return without having to employ riskier investment strategies, although actual performance depends on the investment. 
• Emphasize Funds Over Individual Stocks: Mutual funds or ETFs can provide steadier performance over buying individual stocks. These funds allow you to invest in a collection of stocks, bonds, or other assets. While you certainly can lose money in these funds, the impact tends to be more balanced given the spread. 
• Choose a Practical Management Strategy: Timing the market is difficult at the best of times, putting you at risk for buying right at the peak or selling just before a huge increase. Passive management is often the more practical and effective choice, especially for longer time horizons. 

Although these practices are accessible to almost anyone, it takes time and experience to know which choices are more effective for specific investments or goals. 

Putting Risk Controls in Place: Monitoring, Rebalancing & Stress Testing 

Once you have a risk management plan in place for your portfolio, you must keep monitoring it to see how it performs. Your risk tolerance will change over time, as you become more confident in the performance of your portfolio or want to lower the risk of your overall allocation as you approach retirement. Ongoing management includes: 

• Guidelines and Limits: Setting specific thresholds that trigger certain actions, like rebalancing or exercising options, makes it easier for your portfolio manager to make decisions according to your financial goals. 
• Periodic Review: Reviewing your portfolio at least quarterly or more frequently can give you a better sense of how your investments are performing and provide an opportunity to discuss necessary changes with your portfolio manager. 
• Scenario/Stress Testing: Testing out how your portfolio might perform under certain circumstances, like an early retirement or sudden market drop, can help you plan ahead to mitigate your risk. 

Portfolio Advisors uses various risk metrics as part of our financial planning services. We determine the level of diversification, cost, and risk exposure for your investment holdings. With this information, we can help you better understand your portfolio’s investment risk and determine possible potholes with your current investment strategy. We can provide paths to align your investments with your goals and your personal risk tolerance. By helping you focus on what you can control, we can assist you in having a better investment experience. We emphasize practical, time-tested decision-making, so that you feel more comfortable structuring your portfolio for growth over time instead of trying to time the market. 

Behavioral Risk and Common Investor Mistakes 

When you watch the stock markets, you might not realize the millions of decisions and volumes of information that go into the day’s performance. Markets may go up or down, even when experts predicted that it would go another way. With millions of participants, you can’t guarantee what will happen, even if something really impactful happens in the news. 

Letting your emotions govern your decisions can cost you in the long run. Following the herd in a selloff might cause you to sell at a much lower price than you would if you had stuck through the rebound. Overtrading, or the constant buying and selling of stocks, can increase your total fees and make you more prone to costly errors. Even neglecting small losses can be problematic, especially if it causes you to hang onto a failing asset much longer than necessary. 

Ultimately, relying too heavily on short-term predictions rather than broader market fundamentals can increase overall portfolio risk. We prefer to harness that collective knowledge to help it work for you, instead of trying to beat it. Professional portfolio management can provide informed oversight and decision-making aligned with your long-term financial goals. Portfolio Advisors offers experienced guidance and clear perspective during periods of market volatility, helping you remain disciplined and aligned with your long-term investment strategy. 

Building a Resilient Portfolio for the Long Run 

The ultimate goal of understanding investment risk is to help you build a resilient portfolio that can continue to grow over time, even if certain assets periodically lose value due to volatilities in the market. To get this outcome, you’ll need to balance your investments in a way that mitigates risk to a level you can manage. These best practices are key to getting the most from your investments long-term: 

• Making sure you are familiar with common investment risks, especially for the particular assets you have or intend to hold 
• Establishing your risk appetite and adjusting it over time, as your financial situation and priorities change 
• Diversifying your portfolio so that you don’t have too much money in the riskiest types of investments 
• Aligning your portfolio to suit your risk tolerance 
• Monitoring your portfolio over time 
• Using techniques like rebalancing to keep your allocation in check 
• Avoiding making sudden changes to your portfolio based on temporary conditions 
• Building confidence in your portfolio over time, so you feel comfortable staying the course 

To get long-term success, you typically are better off staying invested through occasional volatility, even if that means your total value dips on occasion. 

Optimize Your Risk Management With Portfolio Advisors 

Are you aware of the risks you face with your current investments? Do you worry about how market shifts might affect your long-term financial plans? Learning more about investment risk and how you can manage it is the best way to ensure you get through the years with your portfolio intact. At Portfolio Advisors, we specialize in personalized risk management strategies and portfolio review. Contact us to discover how we can optimize your portfolio to your individual risk tolerance and financial goals. 

Disclosures: This material is for informational purposes only and should not be considered investment advice. Past performance is no guarantee of future results. Investing involves risk, including the potential loss of principal.