Understanding the Hidden Risks Inside Your Portfolio
Understanding the hidden risks inside your portfolio can be a challenge, especially if you don’t understand the ins and outs of investing and the current market trends. When it comes to managing your money, investment decisions are oftentimes too complicated for the typical investor to process and managing your portfolio can seem like a time consuming chore. At Ivy Ridge Asset Management in Rhinebeck, our financial advisors have helped add value to thousands of investors through our customized portfolio management services. If you need help managing your portfolio, contact our registered investment advisors today.
Reduce Your Portfolio Risk By Diversifying
When you work with a financial advisor to assess and manage your portfolio, they can help reduce your exposure to individual asset risk by diversifying your portfolio. In the laymen’s terms, this means not putting all of your eggs in one basket. A basic, diversified portfolio may include a variety of investment categories like cash, stocks, mutual funds, private equity and bonds. In order to make the best allocation decision when it comes to diversifying your portfolio, these investment decisions should be based on a few things:
- Your individual investment goals
- Your tolerance for risk
- Your timeframe of earning
For most investors, the risk they take when they buy a new stock is that the return will be lower than expected. In other words, they may not recoup all of the money that was spent on purchasing the stock if the market plummets or the company abruptly goes out of business. At Ivy Ridge Asset Management, our financial advisors utilize Riskalyze, a state-of-the-art online platform that helps pinpoint an investor’s risk number to successfully build a fruitful portfolio. Once our financial advisors have an understanding of your individual measure of risk and return, they’ll be able to make an informed decision on how to best diversify your portfolio.
Minimize Your Portfolio Interest Rate
If you’re concerned about your portfolio’s rising interest rates, an educated financial planner can help you find ways to reduce the amount of interest you pay. One financial strategy we’ve seen to be successful can be accomplished by selling longer duration investments in favor of shorter ones. Investors also have the option of adding shorter duration investments to bring down the average duration of their portfolio. Many investors who position their portfolios as such believe that the yield they give up will be more than made up for by avoiding the price loss that a longer duration portfolio would experience in an environment of rising interest rates.
If you’re considering moving to shorter duration bonds, there are a few consequences to keep in mind. Since shorter maturity bonds have a lower yield, their investment returns may not keep on pace with the market’s inflation. After inflation, which has recently been trending around two percent, investors run the risk of negative yield levels. It is also important to remember that a short duration bond portfolio may not generate enough yield to achieve your financial goals in the long run.
Modern Portfolio Theory
According to the Modern Portfolio Theory (MPT), a hypothesis created by Harry Markowitz in his paper Portfolio Selection, risk-averse investors can construct portfolios to optimize or maximize their expected return based on a given level of market risk. Also known as the portfolio theory, MPT suggests that it is possible for investors to construct an optimal portfolio by investing in more than one stock and diversifying their portfolio. According to Markowitz, the process of selecting a portfolio may be divided into two distinct stages.
The first stage begins with observation and experience and ends with educated beliefs about the future performance of your portfolio. The second stage starts with relevant beliefs about future performances and ends with the type of portfolio you choose. The Modern Portfolio Theory also states that the risk for individual stock returns has two overarching components:
Systematic Risk- These risks are market risks that cannot be diversified away in your portfolio. These can include interest rates, recessions and wars.
Unsystematic Risk- Also known as specific risks, these risks are specific to your individual stocks and can eventually be diversified away as you increase and diversify your portfolio. These risks represent the components of a stock’s return that is uncorrelated with general market moves.
Understand Your Funds & Their Volatility
If you already have a diverse portfolio of stocks and bonds, it may be difficult trying to decide which funds will provide the best risk-reward combination for financial success. According to the Modern Portfolio Theory, one way to examine the relationship between portfolio returns and risk can be done by referencing the efficient frontier. The efficient frontier is the set of portfolios that offers the highest expected return for a defined level of risk. If your portfolio falls below the efficient frontier, it may not provide enough return for the level of risk it is associated with.
When it comes to choosing the best investments for your portfolio, you’ll want to select securities that fit with your individual needs and financial goals. If you are a risk-seeking investor, you’ll want to choose securities that lie to the right end of the efficient frontier curve. These investments can include securities that are anticipated to have a high degree of risk with a high potential of return. For those investors who are looking to play it safe, choosing securities that lie on the left end of the efficient frontier may be more suitable.
At Ivy Ridge Asset Management, our financial advisors believe that everyone should have access to an unbiased opinion, especially when it comes to your finances. As an independent investment advisory firm in New York, our primary objective is to build and preserve wealth for our clients through a variety of financial services. Whether you need assistance managing your portfolio or planning for retirement, our registered investment advisors are happy to help. Contact our Rhinebeck office today to learn more about our financial services and how we can help grow your portfolio!