About the author: Lamar Watson, CFP®, is a Fee-Only Financial Advisor in the Washington, D.C. area that works with clients virtually across the country. Lamar's work with his clients starts with a focus on budgeting, insurance, optimizing employee benefits, investing, and retirement planning. Dream Financial Planning is a Fiduciary Financial Planning firm specifically designed to help individuals in their 30s and 40s take control of their finances and fulfill their dreams. Feel free to schedule a complimentary consultation to learn how we use the DREAM Financial Planning Process ™ to help our clients achieve their goals.
Is Your Portfolio at Risk?
Whether your retirement is years away or right around the corner, your investment portfolio should be designed with your financial goals in mind. It needs to be forward-thinking enough to handle the whims of the market but flexible enough to make changes on the fly.
One of the most important concepts for any investor to understand is asset allocation. Put simply, asset allocation describes the division of stocks, bonds, and cash that make up your investment portfolio. Although this concept is straightforward, it has one of the largest impacts on your financial future. In the article 10 Best Tips for Beginning Investors, I discuss how your investment time horizon should impact your asset allocation and the amount of risk you take in your portfolio.
If you feel your portfolio is too risky, it might make sense to get a second opinion. When you work with Dream Financial Planning, we'll craft a customized investment strategy that aligns with your preferred risk tolerance. Here's the analysis of a Sample Portfolio where we analyze your portfolio for risk, returns, and hidden fees.
Our free quiz evaluates several factors, such as your portfolio size, goals, and risk tolerance. In addition to explaining your risk score, the quiz will also provide insight into how to match your asset allocation with your preferences, as well as the performance you can expect based on your risk score. You can learn more about Riskalyze here.
Concentration builds wealth, and diversification protects it, is a phrase I often use with clients. For example, if you're in your 30s and investing for retirement, you have a long time to let your investments grow. Therefore you have the ability to take more risks with your investments. At this age, it might make sense to have a 100% stock or very concentrated portfolio.
For example, if you're in your 30s and have $100,000 in your 401k suffering a $30,000 decline due to a market volatility is a little scary. However, given your age and the long period of time you have to invest may give your comfort you'll make it back. If you're closing in on retirement with a $2,000,000 portfolio that 30% decline is obviously much larger in dollar terms and could negatively impact your ability to retire and you may not have enough time to recoup losses before you need the money.
When it comes to advising clients on investments my goal is twofold. Goal number one is to make sure my clients' portfolio is built with their risk tolerance, goals, and money personality in mind. I want their projected returns to be aggressive enough to meet there goals. At the same time I want them to be diversified enough to weather the inevitable volatility comes with the stock market and prevent them from becoming forced sellers in down markets.
As your wealth grows reducing volatility will become more important. If you're looking for a trusted partner to help you build and protect your wealth feel free to schedule a Complimentary Consultation.
Asset Class Returns and Volatility
The chart below from JP Morgan shows asset class returns from 2008-2022. You can see that the best-performing asset class changes from year to year. If you look all the way to the right you'll see the annual returns for the asset allocation portfolio. The returns are middle of the road at 6.1% but look at the volatility. The volatility was only higher than cash and fixed income, which are conservative investments.
Each asset class has its own set of risks and rewards, depending on your time horizon and financial goals. You and your financial advisor may make adjustments to your portfolio over the years as your needs change.
- Stocks, also called equities, allow you to own a share of a publicly traded company. By investing in stocks, you have the potential for a higher return on your investment. But if the company has a bad year, or if the economy takes an unexpected turn, you may also lose money.1
- Bonds, overall, have been a steadier source of fixed income. However, bonds are subject to interest rates and inflation risks, and their rate of return tends to be lower.1
- Mutual funds and ETFs (exchange-traded funds) are pools of multiple companies in which you can invest. While many mutual funds have a mix of stocks and bonds, some specialize in one or the other. Mutual funds offer less risk than investing directly in stocks, as diversifying your asset allocation tends to spread the risk.1
- Cash and cash equivalents give you flexibility for any unexpected emergencies that may arise. If your hot water heater dies, having funds on hand to take care of it without resorting to a credit card is helpful. However, your cash-on-hand cannot earn you money the way other investments might.1
Finding A Balance
When it comes to managing your portfolio, asset allocation requires a more hands-on approach. “Setting it and forgetting it” may sound appealing, but changes in the market warrant a portfolio review to make sure your asset allocation still makes sense. Working with a financial advisor is a great way to make sure that your asset allocation reflects your goals, and they can help make adjustments to any changes that life throws your way.1
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Disclaimer: Dream Financial Planning, LLC does not warrant that this information will be free from error. None of the information provided on this website is intended as investment, tax, accounting, or legal advice, as an offer or solicitation of an offer to buy or sell, or as an endorsement of any company, security, fund, or other securities or non-securities offering. The information should not be relied upon for purposes of transacting securities or other investments. Your use of the information is at your sole risk. Under no circumstances shall Dream Financial Planning, LLC be liable for any direct, indirect, special, or consequential damages that result from the use of, or the inability to use, the materials in this site, even if Dream Financial Planning, LLC or a Dream Financial Planning, LLC authorized representative has been advised of the possibility of such damages. Please consult with your own advisor before making any changes to your Financial Plan, Investments, or Insurance coverage.