From time to time, it is a good idea to review how your portfolio assets are allocated – how they are divided among asset classes.
At the inception of your investment strategy, your target asset allocations reflect your tolerance for risk. Over time, though, your portfolio may need adjustments to maintain those target allocations.
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.
To put it another way, the passage of time and the performance of the markets may subtly and slowly imbalance your portfolio.
If too large a percentage of your portfolio is held in stocks or equity investments, you may shoulder more investment risk than you want. To address that risk, your portfolio holdings can be realigned to respect the original (target) asset allocations.
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, no matter how stocks fare.
Downside risk – the possibility of investments losing value – can particularly 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.
Underdiversification risk can also prove to be an Achilles heel. As a hypothetical example of this, 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.
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, and therein lies the appeal of a balanced investment approach, with the twin goals of managing risk and encouraging an adequate return.
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