Investment Risk Management

Most investment advisors suggest that young people take too much risk, while at the same time they tell retired people not to take enough risk. What we try to achieve is a balance between reward and risk. Sure younger investors should take more risk than retired investors, but in both cases it is also important to consider balancing your risk. The typical middle of the road investment portfolio consists of 60% Stocks and 40% Bonds. When looking at it from the perspective of how the risk is distributed in your portfolio, you actually have 86% invested in Stocks and 14% invested in bonds. Even worse, the typical portfolio has over half of its risk from investing in Large Cap Stocks. Clearly there must be a better way.

A better approach to asset allocation and portfolio diversification is to create a far more diversified portfolio that has less exposure than equities than most people have. Our target, or as we like to call it, Insightful Asset Allocation, has far more asset classes than provided by target date funds, or the typical investment advisor. Most people would be better off with a portfolio built the opposite way, with 60% Bonds and 40% Stocks. That in itself would improve the risk characteristics of your portfolio. Even better would be to take that “Swing” 20% and put it in hedged equities and commodity futures. In addition, the bond portion of your portfolio should be far more diversified than what it most likely is today. At the very least, you would do better in the long run with a portfolio that is only getting 60% of its risk from Stocks, and getting the rest from Bonds and other asset classes.

If you are getting close to retirement age, or you just have a conservative leaning for your investments, your portfolio should have only about 25% exposure to equities such that stocks only contribute about 40% to the risk of your portfolio. Our Conservative Asset Allocation is about has about as balanced of a risk profile as is practical, unless of course you look at our Retirement Asset Allocation.

On the other hand, if you are young, have more than 20 years until retiring, or we are in an excellent economic environment, you can bump up your stock exposure to the 40% level of our Aggressive Asset Allocation, even if this will leave you with 75% of your portfolio risk from equities. Otherwise, we would suggest that you stick with the more moderate targets of our Insightful Asset Allocation.

Learn How to Use Options Investing for Improve Your Investment Risk Management!