Market volatility can be defined as a statistical measure of the returns of a market index or security. This is often associated with big price swings. Usually, when the stock market rises or falls more than 1% over a period of time, it is considered volatile. This is often caused by geopolitical events like an election, a war, a recession, or trade relations. The higher the volatility or price fluctuations, the higher the risk of an asset. Often, newer securities or companies are riskier and prone to bigger price fluctuations, while older companies are historically more established and stable.
Market volatility is a normal part of an investor’s wealth-building journey and is usually factored into long-term portfolio planning.
Just because a stock is volatile does not mean it is a bad investment. It is just a riskier investment and should be balanced with more stable portfolio investments.
A financial risk assessment identifies any risk that may occur, analyses these risks, and finds solutions to protect a portfolio against the risk of losses. This involves determining the investor’s risk profile or risk tolerance and compiling an investment portfolio accordingly. Historical data is used to determine the risk of an asset. Lower risk means looking for investments or assets that are historically more stable, offering stable returns like bonds or gold.
Rebalancing a portfolio every 6-12 months is essential in risk management. A financial portfolio is active and ever-evolving and needs constant maintenance to remain at peak efficiency.
Over time, different assets achieve different returns. For example, a portfolio has a 60% equity and 40% bond weighting; over a year, the equities portion performs very well. The increased equities have overweighted the portfolio with equities (say 70%). A higher equities ratio means a higher risk for the portfolio and will differ from the investor’s risk tolerance. The financial advisor will sell off some of the equities to return to the 60% level to balance the portfolio to its 60/40 ratio.
An investor’s financial goals may change over time due to various factors; for example, saving for a house or retiring at 65 may no longer be goals, as an inheritance covered these savings goals. Big life decisions may have changed, and so may the time frame of savings. An investor must consider whether a current investment portfolio is still suitable.
Also, a person’s risk profile may have changed. With a sudden cash flow of an inheritance, it may no longer be required to grow capital for retirement but maintain the capital. A lower risk tolerance would then be introduced, and the portfolio would be adjusted accordingly.
As investors near retirement, for example, they would move to a lower-risk profile. From a riskier growth profile to a lower risk preservation profile. This means moving from a higher equity weighting to that of higher bonds. Age determines the risk profile of a portfolio; for example, a younger investor can afford to follow a higher risk profile as they have time on their hands to smooth out any volatility.
Asset allocation is vital when trying to manage risk during volatile markets. Different assets have different risks attached to them. Rebalancing a portfolio during prolonged volatility is essential to maintain its profitability, especially for the portfolio’s long-term returns.
This is when a financial advisor investigates the risk of losses to a portfolio and customises a plan to adjust the investments to suit the client’s risk tolerance to mitigate these risks. It involves analysing the assets in a portfolio and their composition to determine a risk level and adding diversification and rebalancing to better bolster the portfolio against the risk of losses.
The length of an investment ultimately determines the risk. Long-term investments have the advantage of time to smooth out volatility and fluctuations. In contrast, shorter-term investments, like 3-5 years, do not have time to recoup losses if markets remain volatile. If the investment term changes, rebalancing must be done for the new investment term and risk level.
History has shown that markets are becoming more volatile due to geopolitical events. To keep your financial portfolio safe from risk, it is imperative to have regular reviews and risk assessments to maintain optimum performance.
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