Do Your Investments Match Your risk tolerance?

From time to time, it is a good idea to review how your portfolio assets are allocated – how they are divided among asset classes.

Target asset allocations should reflect your tolerance for risk. Over time, your portfolio may need adjustments to maintain them. 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. Over time and market performance may subtly and slowly imbalance your portfolio.

If too large a percentage is in stocks or equity investments, you may shoulder more risk than you want. Your holdings can be realigned to respect the original (target) asset allocations. 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 (a statistical measure of how two securities move in relation to each other) to the stock market become appealing. Some investors choose to maintain a significant cash position at all times.

Downside risk – the possibility of investments losing value – can sting investors who are overly invested in momentum/expensive stocks. Historically, the average price/earnings ratio of the S&P 500 has been around 14. A stock with a dramatically higher P/E ratio may be particularly susceptible to downside risk.

Under-diversification risk can also be an Achilles heel. As a hypothetical example, 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 likely be among your priorities.