Navigating Investment Risk for Optimal Portfolios

Effective risk management is crucial for long-term portfolio success. This article outlines the top 20 investment risks that any serious money manager should know and understand, with examples and strategies for controlling and mitigating risk.

Top Twenty Risks Hiding in Investment Portfolios

  1. Market Risk – The risk of an investment declining due to broad market movements and volatility.
  2. Interest Rate Risk – The risk that rising interest rates will cause bond prices to drop or that declining interest rates will reduce returns on money market assets.
  3. Duration Risk – The risk that short-duration bonds underperform if interest rates fall or that long-duration bonds will underperform if rates rise.
  4. Concentration Risk – The risk of adverse events impacting a specific asset or sector concentration to which a portfolio has high exposure.
  5. Credit Risk – The risk that a bond issuer defaults on payment obligations or spreads widen in anticipation.
  6. Liquidity Risk – The risk that lack of market depth and low trading volume makes an asset challenging to trade.
  7. Tracking Error Risk – The risk that a portfolio fails to match the performance of its benchmark.
  8. Active Risk – Risk resulting from active trading strategies, e.g., rapid-fire risk-on / risk-off trades.
  9. Style Risk – The risk that a particular investing style underperforms, e.g., growth vs. value.
  10. Valuation or Mark Risk – The risk that an asset is improperly valued or mispriced.
  11. Inflation Risk – The risk that inflation diminishes the purchasing power of a portfolio’s assets.
  12. Regulatory Risk – The risk that regulatory changes negatively impact the portfolio.
  13. Tax Risk – The risk that portfolio changes create unexpected tax liabilities.
  14. Geopolitical Risk – The risk that political changes negatively impact investment performance.
  15. Currency Risk – The risk that currency fluctuations reduce foreign investment returns.
  16. Business Risk – The risk a company’s business fundamentals deteriorate.
  17. Fraud Risk – The risk that investment fraud causes financial loss.
  18. Correlation Risk – The risk that asset correlations become unstable and increase during market stress.
  19. Volatility Risk – The risk that portfolio volatility exceeds expectations.
  20. Sequence of Return Risk – The risk that the order and timing of investment returns adversely impact overall performance. Retirement income portfolios can be especially vulnerable to this risk.
 

Investing will always involve some level of risk. In other words, investors should recognize and accept that risk can never be eliminated and that tradeoffs exist. Take a look at the table below to see some sample strategies to control risk.

 


Risk TypeRisk Control Strategy
Market RiskAllocate across asset classes like stocks, bonds, cash equivalents, and liquid alts.
Interest Rate RiskAlign portfolio duration with investor time horizon and world view.
Concentration RiskAvoid asset and sector over-concentration.
Credit RiskOwn high-quality investment-grade bonds.
Liquidity RiskLimit exposure to non-marketable private assets.
Inflation RiskInvest in inflation-protected bonds.
Style RiskDiversify across investment styles like value, growth, small-cap, and large-cap.

 

Maintaining a well-diversified portfolio aligned with an investor’s risk tolerance and objectives helps minimize potential risk. It’s equally essential that a competent money manager continuously monitor and adjust portfolio asset allocation as needed. Decision-making should be grounded in evidence-based strategies and robust financial theory, not emotions. Be wary of any advisor who claims an investment has no risk; such claims may warrant considering an alternative advisor.

In summary, partnering with a qualified professional can instill confidence that your portfolio is resilient, aligns with your goals, and effectively manages risk. At Successful Portfolios, our expertise in constructing diversified portfolios and our disciplined risk management approach ensure your investments are positioned for growth opportunities while shielding against undue losses.

If you are concerned about the risks impacting your investments, call or text (727) 744-3614. Prioritizing and managing investment risk is the heart of what we do as professional money managers.

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Talk to Parker Evans, CFA, CFP