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Risk vs Reward

• 021515
• 3 minutes

2015 has already picked up momentum, as new years always do. Everyday concerns demand attention, and calendars flow from one important date to the next. But in the background, big concerns are still lingering: Are my investments diversified enough? Could I safely take on more risk? Is my portfolio performing as well as I hoped? If you weren’t asking, here's betting you are now.

Financial decisions can be weighty and far-reaching, but they are totally worth what you put in. So let’s get down to business and make things happen. Let's work to control investments, before time gets the best of this year.

By now, it’s safe to assume that your year-end statements are old news. 401(k)s, brokerage accounts, IRAs—Received, read and filed. But let’s dive into those numbers. 2014 saw the S&P 500 return 13.7%. How about your portfolio? Did you see gains that rivaled the S&P? Chances are, you're shaking your head right now. Here's a better question: Should you have?

We all know the game: No risk, no reward. Now make the leap from knowing to understanding. Here's the honest truth: If your portfolio reaped a bumper crop last year, you were likely carrying a mother lode in the risk department. And the brains out there will tell you that there is such a thing as too much. What you'll also hear is a plug for diversification: spreading risk around, opting for investments in several asset classes. For while the S&P 500 gained hand over fist, its scope remains limited. Despite its wide endorsement, only large cap stocks are represented—hardly a poster child for diversification. Yet, as a well-known benchmark, S&P 500 gains have become a beacon of financial success. Are we being reasonable, then, in our expectations?

Consider this: the Russell 2000 (Small Cap index) posted a return of just 4.9%, while the MSCI EAFE fell by 4.9%, and the MSCI Emerging Markets fell 2.2%. True, if these investment categories were part of your portfolio last year, you would have seen a negative impact, compared to the S&P 500 alone. So the wise offer these words: Exposure to investments in various asset classes is the difference between elephants and geese. It’s simple financial physics. Who’s more likely to gracefully travail the thin ice that is the financial market? Even if overall, they collectively weigh the same as our pachyderm friend, geese spread the risk of catastrophe by sheer number—and by their nifty webbed feet. If you lose a few, you don't lose it all. And come warmer months, hatchlings will more than make up for the loss. The moral? Diversification and risk distribution are musts if you’re looking to survive market turbulence and enhance long term returns.

Getting back to the behemoth—Morningstar did the math, and that 13.7% return we mentioned earlier would have required roughly 91% allocation to stocks, the majority being S&P. Now imagine that the gain happened to be a loss—OUCH, to put it mildly. Concentrated risk of that weight is more than most of us care to live with. Especially figuring in the S&P 500’s stellar performance over 5 consecutive years, the odds were against 2014 being a win.

After all, past performance guarantees, well—nothing, really. Generally, winning streaks don’t last. In fact, many experts were positive that markets were headed for a correction; so they acted to protect their clients, spreading risk across several asset classes. And not without gains: Morningstar’s most aggressive and best performing asset allocation—with exposure to domestic and foreign bonds, commodities and TIPS—saw a 5.23% increase. Here's the lesson: Caution shouldn’t be equated with loss. Instead, we can see it as wisdom; a way to protect and grow in the long-term. Besides, most of us are investing now with a view to reaping future returns.

So let’s slow it down; put on the brakes before this year rushes past, gather up some of that precious commodity: time, and invest a little. Take a closer look at those portfolios. Because if life circumstances have changed, you can bet your risk tolerance is affected. If added responsibilities or imminent retirement have your finances tied up, try dialing back the risk. Then again, if you're freed up financially, why not assume a little more? Sounds like an honest evaluation is in order. And whichever way your life leans, you'll be fine-tuning the quality of what’s in your portfolio, and that's always a good thing.

From pinpointing goals, to figuring your ideal benchmark—Let’s make your money work for you. And remember: While it's easy to feel that diversification is a loss, that's no reason to go chasing waterfalls. In these topsy-turvy markets, we’re betting on consistency over time, not an overnight win. Here’s where your patience can, quite literally, pay. Ultimately, this is your money: Let’s tell it where to go and how to get there.

• financial planning
• investing
• market fluctuation
• stock market
• financial risk
• diversification