Key takeaways

  • A key goal for investors is not just to generate competitive returns, but to do so while limiting the amount of risk.

  • You need to be aware of a wide variety of portfolio risks, from rising interest rates to currency movements.

  • Implementing diversification strategies can help “smooth” portfolio performance over time.

Generating competitive returns tends to be the dominant focus of many investors’ portfolio decisions. Yet just as important is the process of managing risk to limit potential losses; in periods of significant market downturns, managing risk tends to become a higher priority.

Maintaining a long-term investing strategy through volatile market periods typically requires a diversified investment approach. Diversification involves spreading your investment dollars among different types of assets to help temper market volatility. By “smoothing out” market performance, you may be more likely to maintain a long-term portfolio position, potentially improving your chances of meeting key investment goals.

Diversification involves spreading your investment dollars among different types of assets to help temper market volatility.

As a simple example, all equity (or stock) investments and most fixed income (or bond) investments are subject to market fluctuation. Owning a mix of stocks and bonds usually helps limit short-term volatility. During periods when stocks are struggling, bonds may perform better, helping to offset the negative returns in stocks. At other times, stocks may significantly outperform bonds.

 

Different risks to consider

It’s important to account for different types of risk that could affect portfolio performance. These include:

  • Interest rates. Changes in interest rates can affect the market value of holdings in your portfolio, particularly bonds. If rates decline, existing bond values rise. If interest rates increase, bonds held in your portfolio will lose value. “Changes in the interest rate shift prices for fixed income investments, either improving or diminishing total returns,” says Rob Haworth, senior investment strategist for U.S. Bank.
  • Inflation. Changes in the cost-of-living can impact the investment environment and the net returns earned on investments after accounting for inflation’s impact. “Certain asset classes generally benefit more from a higher inflation environment,” says Haworth. “These include real estate and infrastructure firms.” Including such holdings in a diversified portfolio can help offset the volatility experienced by other assets during high inflation cycles.
  • Individual security. “It’s important to avoid adverse selection or investing a large percentage of your portfolio in a single security that proceeds to lose significant value in the market,” says Haworth. An overweight position in an individual stock is a particular risk for employees who put large sums of money into company stock or for families who have their wealth primarily tied up in their own company. “Trying to build wealth by directing most of your investments into a single company is taking on a lot of unnecessary risk,” says Haworth.
  • Government/central bank policy. Policy decisions regarding tax rates, government spending, trade and international relations can impact the investment environment. The direction of monetary policy established by central banks (such as the Federal Reserve) is another variable often reflected in the markets. “These policies often change the pace, trend or magnitude of economic and investment fundamentals,” according to Haworth.
  • Currency movements. Those investing in foreign-based stocks or bonds could see results affected, either positively or negatively by currency movements. In general, if the value of the dollar versus other currencies, declines, it will benefit those with money invested abroad. If the value of the dollar rises, it can detract from net performance for U.S. investors. “This is an important, uncompensated risk for those who hold foreign bonds,” says Haworth. “For those with international equity positions, growth in earnings is generally considered sufficient to overcome currency risk.”
  • Time horizon. The amount of time your money can remain invested will impact your diversification strategy. “The risk of loss is much more pronounced over any given one-year period, compared to holding it for ten years or more,” says Haworth. The longer you can remain invested, the greater the opportunity to overcome any temporary setbacks to your portfolio.

 

Three diversification strategies that may help mitigate risk

Building a diversified portfolio can help you manage risk. Here are three diversification strategies to consider as you make your investment decisions:

  • Invest in a variety of asset classes. Stocks and bonds should make up most of your portfolio. However, within those broad classifications are a variety of asset categories. For example, stocks vary by market capitalization (small-cap, mid-cap and large-cap stocks). They’re also differentiated into growth or value classifications within each of those market capitalization categories. Bonds may include investment grade and below investment grade (junk) bonds, or municipal (tax-free) bonds. Haworth notes that lower-grade bonds often share performance characteristics with stocks, so they provide less diversification benefit to an equity portfolio than is the case owning high-quality bonds.
  • Own assets representing different sectors. Within a stock allocation, diversification among a variety of industries can help mitigate risk. “If you own a concentration of technology company stocks,” says Haworth, “you really need to diversify your exposure around that.” If the technology sector lags the performance of other parts of the market, it will drag down the performance of your portfolio. This is true of other sectors as well. Positioning your equity portfolio across a broad spectrum of industry sectors can help smooth performance through different market environments.
  • Include foreign investments in the mix. International stocks make up approximately 40% of the world equity market’s value. Diversifying into global stocks provides returns that tend to be differentiated from those of U.S. markets and benefits from economies that may be on a different growth path compared to that of the domestic economy. It opens up potential new opportunities to benefit from growth overseas.

 

Assess your own portfolio

A properly-diversified portfolio can help you achieve more consistent returns over time, which may improve the opportunity to attain your ultimate financial goals. Your financial professional can help you determine if there are ways to enhance the level of portfolio diversification in your current investment mix.

Learn more about our approach to investment management.

Diversification and asset allocation do not guarantee returns or protection against losses.

There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards and other risks associated with future political and economic developments. Investments in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Investment in fixed income securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities. Before purchasing a certificate of deposit (CD), investors should understand all terms and carefully read any disclosure statements. CDs have a maturity date and if money is withdrawn prior to this date, investors may be penalized with a fee. Investors should also confirm the interest rate that will be paid and at what interval payment will be made.

Related articles

5 types of bonds to help diversify your portfolio

Looking to diversify your investment portfolio without increasing instability in a volatile market? Consider these bonds with a lower-risk profile.

6 reasons to consider a buy-and-hold strategy for long-term investing

Rather than trying to time the market, consider holding on to stocks and other securities regardless of market fluctuations.

Disclosures

Start of disclosure content

Investment and insurance products and services including annuities are:
Not a deposit • Not FDIC insured • May lose value • Not bank guaranteed • Not insured by any federal government agency.

U.S. Wealth Management – U.S. Bank | U.S. Bancorp Investments is the marketing logo for U.S. Bank and its affiliate U.S. Bancorp Investments.

Start of disclosure content

U.S. Bank, U.S. Bancorp Investments and their representatives do not provide tax or legal advice. Each individual's tax and financial situation is unique. You should consult your tax and/or legal advisor for advice and information concerning your particular situation.

The information provided represents the opinion of U.S. Bank and U.S. Bancorp Investments and is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific investment advice and should not be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation.

Start of disclosure content

For U.S. Bank:

Equal Housing Lender. Deposit products are offered by U.S. Bank National Association. Member FDIC. Mortgage, Home Equity and Credit products are offered by U.S. Bank National Association. Loan approval is subject to credit approval and program guidelines. Not all loan programs are available in all states for all loan amounts. Interest rates and program terms are subject to change without notice.

U.S. Bank is not responsible for and does not guarantee the products, services or performance of U.S. Bancorp Investments, Inc.

U.S. Bank does not offer insurance products. Insurance products are available through our affiliate U.S. Bancorp Investments.

Start of disclosure content

For U.S. Bancorp Investments:

Investment and insurance products and services including annuities are available through U.S. Bancorp Investments, the marketing name for U.S. Bancorp Investments, Inc., member FINRA and SIPC, an investment adviser and a brokerage subsidiary of U.S. Bancorp and affiliate of U.S. Bank.

U.S. Bancorp Investments is registered with the Securities and Exchange Commission as both a broker-dealer and an investment adviser. To understand how brokerage and investment advisory services and fees differ, the Client Relationship Summary and Regulation Best Interest Disclosure are available for you to review.

Insurance products are available through various affiliated non-bank insurance agencies, which are U.S. Bancorp subsidiaries. Products may not be available in all states. CA Insurance License #0E24641.

Pursuant to the Securities Exchange Act of 1934, U.S. Bancorp Investments must provide clients with certain financial information. The U.S. Bancorp Investments Statement of Financial Condition is available for you to review, print and download.

The Financial Industry Regulatory Authority (FINRA) Rule 2267 provides for BrokerCheck to allow investors to learn about the professional background, business practices, and conduct of FINRA member firms or their brokers. To request such information, contact FINRA toll-free at 1-800‐289‐9999 or via https://brokercheck.finra.org. An investor brochure describing BrokerCheck is also available through FINRA.

U.S. Bancorp Investments Order Processing Information.

Municipal Securities Education and Protection– U.S. Bancorp Investments is registered with the U.S. Securities and Exchange Commission and the Municipal Securities Rulemaking Board (MSRB). An investor brochure that describes the protections that may be provided to you by the MSRB rules and how to file a complaint with an appropriate regulatory authority is available to you on the MSRB website at www.msrb.org.