When markets are enjoying strong returns, as is the case currently, investment portfolio risks may not be a primary concern for many investors. But bull markets don’t last forever.
A fundamental principle of successful investing is vigilance toward risks over time. For example, here are common risks across stocks and bonds.
- Credit risks. A potential deterioration in a bond issuer’s financial strength, typically among bonds rated below investment grade, such as high-yield bonds. This diminishes a company’s ability to pay interest and principal on outstanding debt and potentially default on its bond.
- Interest rate risks. The possibility that prevailing market rates could rise, causing a decline in the principal value of outstanding debt.
- Liquidity risks. The possibility that some securities may have relatively few interested buyers or sellers, potentially raising the transaction cost.
- Operating risks. Any potential disruption to conducting business, such as current bottlenecks in the global supply chain with semiconductor production and shipping backups.
- Competition and disruption risks. The pressures to stay relevant in the marketplace with better products, attractive pricing and innovation.
- External shock risks. Business threats, such as the COVID-19 pandemic, that come from outside the normal operating environment and test the resiliency of any business.
The personal balance between risk and reward
Your Ameriprise financial advisor can offer personalized investment recommendations — across a variety of asset classes — to support your financial goals and help mitigate risk. Importantly, the recommendations need to align to your tolerance for risk.
Many investors think of portfolio volatility when they consider risk. How much volatility you are willing to accept is an important determinant of how your portfolio should be constructed. The following chart summarizes those aspects across five categories of risk.
Knowing your risk tolerance helps to identify the appropriate tradeoff between volatility and expected return. For example:
- An investor with a high risk tolerance might be comfortable with more exposure to stocks and the higher expected volatility in return for the historically higher expected returns.
- Conversely, someone with a low risk tolerance might be more comfortable with greater exposure to bonds and cash with potentially lower but more predictable expected returns.
How risk factors into life stages
Building a suitable portfolio is also influenced by life stage — whether just beginning your working life, at a career midpoint or in retirement. Your financial advisor may also consider your accumulated wealth, investment experience and tax status.
Different investment objectives, with different time horizons, may require portfolios with different risk tolerances. For example, a 30-year-old investor might have a higher risk tolerance in a retirement portfolio than with their savings if they have a goal of buying a house within the next five years.
Risk cannot be eliminated. Even the safest investments contain some risk, including the risk of diminishing purchasing power over time. But risk can be mitigated. Beyond the fundamental steps of identifying your risk tolerance and building a well-diversified portfolio, there are additional strategies your financial advisor might recommend.
For example, investing in low-volatility stocks, emphasizing high dividend payers or investing in alternative assets might be appropriate. It is also possible to employ hedging strategies to protect existing positions and preserve the capital you have accumulated.
If you would like to discuss strategies to mitigate investment risks and review your portfolio, please speak with your Ameriprise financial advisor. They are committed to helping you achieve your financial goals with personalized advice and investment recommendations.