Today’s topic on risk is Market Risk. This type s of risk is having a sizable portion of your portfolio invested in a single market segment or asset class. The consequence of exposure to this type of risk is that when that market segment or asset class has a downturn, so will the value of your portfolio.
Of course, just by owning equities, you bear some Market Risk because there have been times (such as in the 1929 market crash, on Black Monday in 1987, and during the immediate period post 9/11/2001) when nearly every stock in every market segment dropped at the same time. More likely, however, is the situation where one market segment (such as Technology stocks) or one asset class (such as U.S. Large cap stocks) drops. With any of these situations, your portfolio will be severely affected if you have substantial holdings in that market segment or asset class.
One of the main ways to decrease this risk in your portfolio is to diversify between many different asset classes. In order to have a prudently diversified portfolio, you must have your investments spread out among differing types of securities. There is a way to actually measure whether you have a diversified portfolio. It is learning more about the idea of correlation. A simple definition of correlation is how similarly (positively correlated) or dissimilar (negatively correlated) do different types of assets move. This is a VERY important part of any portfolio, and if you do not know what this means or perhaps you have never even heard of this then you probably need to come into our office to discuss this. Remember, you do not need to know everything about investing, just a few of the right things!