Risky Business (Part 1)

So how do you do it?

How do you handle the bumpy rides and hot kitchens that emerging markets and small stocks tend to be? After all, most of us have IRAs or 401(k)s that we need to invest, and those are our retirement funds that we see jumping around on the screen. Many folks took the “see no evil” approach of just not opening their statements during the crisis. While that may keep us from panicking, it’s not wise just to close our eyes. A rational investor understands that risk is everywhere, and a main goal of investing is to manage that risk.

The main tool for dealing with risk is diversification. By spreading investments around, investors minimize the chance that any single problem will overwhelm their portfolios. But diversification only works if it’s carefully planned. For example, a portfolio with gold, gold-mining stocks, and real-estate around a gold mine isn’t really diversified.

Diversification must expose the portfolio to as many different factors in as many different ways as possible. The factors—like oil prices, interest rates, consumer demand, agricultural harvests—lead to both the risks and the opportunities. The ways a portfolio is exposed to them are via the different asset classes.

These asset classes—stocks, bonds, and land—respond to factor changes in different ways. That’s why investments that work for some might not work for others. But by being aware of the risk factors—and the assets that bear them—careful investors can design a portfolio that helps them meet their goals and also lets them sleep at night.

Douglas R. Tengdin, CFA
Chief Investment Officer
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