Risk? We all take risks. We like to leave the house and get out and about don't we? But how do we measure our risk? Generally we can balance our risk in driving a car by getting automobile insurance. I wish I could say the same about investments.
We all take on risk when we invest. The question is how much and what can we tolerate?
If you read the fine print on all investment prospecti, you will see that there is always risk involved with investment and that there is risk that your money will decrease by investing. I encourage everyone to read those statements and repeat them in your sleep. Investing is not for the faint of heart. If you can't tolerate risk, buy US Treasury Bonds and sleep better at night.
I know that international stocks are more risky than domestic stocks. I know that small- and mid-capitalization stocks are more riskly than large-capitalization stocks. And stocks are more risky investments than bonds. I know that municipal and government bonds are less risky that corporate bonds. And Cash is King. That's all I need to know about risk as a lay person. How so?
I can take a list of investment options, i.e. mutual funds, in my 401K plan and use it to figure out where I should "allocate my assets". Asset allocation is a huge part of portfolio planning. When you "re-balance" your portfolio, you are changing your asset allocation, generally to meet some targeted level of risk. You're selling off one asset to buy another, but keeping it all in your portfolio.
For instance, I am in my early 30's. I keep about 99% of my money invested in US stock funds. I only recently started buying a US government bond fund when interest rates started to rise. I pretty much stayed pegged to a large cap index fund like the S&P 500 funds because I was a lazy investor back in the day.
Now that I'm a little more savvy about international markets, I have added an international fund into my mix of stocks and bonds. Not too much, but about 15%. Taking on that risk means I have access to greater rewards, and it's true. I have seen my best fund performance in the last 6 months in my international fund, while my domestic stock funds have been flat or slightly negative. Hooray for asset allocation and balanced risk!
So how do I know what is the right mix to have? Study the charts of 'targeted retirement funds'. Mutual Fund companies publish their asset mix for these funds on their website so that you can understand how they are allocating assets and balancing risk. Every once in a while, you should 're-balance' your portfolio and try to match the mix represented by the targeted fund you've selected.
In writing my prior post
, I took a look at Fidelity's 2035 targeted fund
. It has about 17% international funds, 66% domestic stocks, 9% "investment grade fixed income", 8% "high yield fixed income". uh what? Fixed Income? Those are fancy code words for bonds. Bonds pay a fixed income of interest, hence the name. Truthfully, I'm guessing that "investment grade fixed income" means corporate bonds, and "high yield fixed income" means US Treasury bonds, but I don't know that for sure.
I see that I'm holding the right amount of international funds, but not enough bonds. That's actually kind of scary. But I really, *REALLY* like risk. I hold about 3% in cash and US bonds. Over time, I should probably buy more bonds, slowing down risk and making my portfolio more conservative. Imagine that. That's what I need to do anyway as I grow older and wish to preserve the gains I've made in the market over 20 years.
In fact, study the pie charts on this page
very carefully. You'll see that their target retirement funds closer to 2006 have significantly fewer stocks, more bonds, and more short-term instruments (code word for cash or cash equivalents). As you move further away from 2006 towards 2040, you'll see that nearly all the funds get rid of the short-term instruments and high yield fixed income instruments disappear from the asset mix.
I hope this post makes sense. It's a bit stream of consciousness about how I think about my asset allocation and the amount of risk I take on. I feel as a younger person, I can tolerate lots of risk since the rewards are great. I also know that I have a lot of time to make up for any losses I bear with the risk. At the same time, I balance my risk by having a mix of investments so that I'm unlikely to lose absolutely everything. Investing isn't a zero sum game, everything in my portfolio could fall at once, but in balancing risk, I am not likely to lose all my money at once (unless something else very catastrophic happens).
If you're still very confused by all this. TALK TO AN INVESTMENT PROFESSIONAL. And read. Read a lot. There is a lot of good, free information out there available to people who invest in 401K's. There's good investment in books by gurus too, I am sure. Take the time to educate yourself. Empower yourself through knowledge. I know I sound like a PSA, but I'm nobody special. I'm not a CPA, CFA, or CFP. I'm just a person who reads a lot. Take what I say with a grain of salt, re-read my disclaimer, and talk to a professional.