Your Guide to Managing Portfolio Risk

As an advisor, your ability to monitor your clients’ portfolios and reduce risk isn’t just a nice value-add… it’s the very cornerstone of what you do for your clients. When a client’s portfolio is at risk of not achieving their goals, it has the potential to cause serious financial harm—and it may jeopardize your reputation and good standing with regulators.

But what, exactly, does a portfolio at risk mean for advisors, and what can you do to ensure your clients appropriately balance risk and return while staying on track toward their financial goals? Let’s find out.

What Does “Portfolio at Risk” Mean in Investments?

When we say “portfolio at risk,” we’re referring to a portfolio that’s become overexposed to threats that, ultimately, could derail the investor’s financial goals—or, in the worst-case scenario, diminish the wealth they’ve worked so hard to earn.

Risk comes in a few forms, but each has the potential to impact your client’s financial well-being or goals in a big way. These include:

• Underperformance Risk: When the portfolio’s assets don’t perform to your expectations, they may miss benchmark returns or financial goals.
• Strategy Misalignment: Straying from the intended investment strategy or asset allocation. This can happen as some assets perform better than expected (or worse than expected), and their percentage within a client’s portfolio increases unintentionally.
• Outcome Risk: When a portfolio performs inadequately due to excess and inappropriate risk, it may fail to meet your client’s specific life-stage objectives, such as enjoying retirement or paying for a child’s college education.

As an advisor, it’s your responsibility to be intimately familiar with these risks and proactive in preventing and identifying them within your clients’ portfolios. 

5 Common Causes of a Portfolio at Risk

What puts a portfolio at risk? We can attribute portfolio misalignment and risk to several potential factors, which include:

#1: Lack of Diversification

Over-concentration in a single asset class (like stocks or bonds), sector, or geographic region unnecessarily exposes portfolios to greater levels of volatility. A well-diversified portfolio spreads exposure across a diverse set of asset classes and incorporates investments across various sectors and countries of origin. Doing so reduces the risk that one poor-performing asset will bring down an entire portfolio since the other assets are able to balance out the loss with returns.

#2: Market Volatility

An unexpected economic event (like a sudden rise in inflation) can lead to potential downturns and fluctuations in the stock market. As a result, your clients’ portfolios may experience more turbulence and volatility than usual. Limiting a portfolio’s risk level during varying market environments can help you and your clients pursue growth opportunities while maintaining a level of protection from sudden volatility.

#3: Misaligned Risk Tolerance

Portfolios that don’t align with a client’s risk comfort level or financial goals can expose them to an irresponsible level of risk. On the other hand, a portfolio that’s too conservative may struggle to maintain pace with inflation or achieve a client’s desired long-term goals.

#4: Neglected Rebalancing

As market conditions shift, failing to realign a portfolio with its intended strategy or asset allocation (for example, 60% stocks and 40% bonds) could result in unintended risk exposure.

#5: Behavioral Biases

When investors allow their behaviors and biases to rule their decision-making process, they are more likely to succumb to impulsive, short-sighted actions like panic selling during a downturn, chasing trends, or trying to time the market. When left unchecked, these actions can lead to long-term losses and derail an individual’s investment strategy or financial goals.

6 Strategies to Mitigate Portfolio Risk

With an understanding of why too much risk can be detrimental to your client portfolios and their general financial well-being, let’s focus on six strategies for mitigating or reducing risk.

#1: Regular Reviews

As your client portfolios earn returns or experience losses, their asset allocation and levels of risk will shift—meaning they could shift away from what’s considered an appropriate level of risk for each client. As a financial professional, your job is, of course, to consistently monitor and reassess those portfolios for such changes. 

#2:  Strategic Asset Allocation

Building an appropriate asset allocation strategy means balancing your clients’ investments across multiple asset classes with varying levels of risk and growth potential including stocks, bonds, cash or cash equivalents, and alternatives. 

#3: Diversification

Diversification is one of your most effective tools for reducing risk. As we mentioned earlier, diversification is achieved by spreading investor capital across varying asset classes, sectors, and geographic regions.

You will likely want to include a mix of growth-oriented investments and more stable assets to balance each portfolio’s risk and return potential. Generally speaking, the goal is to avoid over-relying on any one single investment or asset type, as doing so can amplify potential losses and impact too much of an investor’s portfolio during a market downturn.

#4: Rebalancing

Rebalancing involves realigning a portfolio’s asset allocation to match its original strategy. This is particularly important during periods of market volatility, where some assets may significantly outperform or underperform compared to your original investment thesis or strategy. By rebalancing regularly, you can essentially “lock in” the gains of overperforming assets while maintaining the portfolio’s intended risk level. 

#5: Risk Tolerance Assessment

Your client’s risk tolerance isn’t static, it’s meant to evolve as they experience changes in life. Throughout the advisor-client relationship, you’ll need to continually make adjustments as their goals, income level, family status, or other life circumstances change over time.

#6: Focus on Long-Term Goals

Market fluctuations can certainly be scary, which is why encouraging clients to maintain a long-term perspective is key to helping them stay focused on their broader financial objectives. Encouraging them to ignore the day-to-day movements of the market can help them avoid making impulsive or emotionally driven decisions about their portfolios.

Leveraging Technology for Risk Assessment

Today’s leading technology is transforming how financial advisors approach risk management, as various tools on the market can help investors and professionals quantify their risk tolerance and portfolio risk.

Some advisors use quantitative measures, like Nitrogen’s Risk Number® to align their clients’ risk preferences with their portfolios. By assigning a numerical value to an investor’s risk tolerance and portfolio alignment, Risk Number® takes the guesswork and ambiguity out of risk tolerance for individual investors. 

By leveraging risk-focused tools like the Risk Number®, you may be able to help your clients better visualize the impact and effectiveness of their portfolios’ asset allocation, as well as maintain realistic and clear expectations about portfolio performance.

Solidify Client Relationships with Nitrogen

Balancing risk and growth potential is an ongoing concern for all investors, which is why more financial professionals are embracing technology-driven solutions like Nitrogen to help solidify portfolio research and create stronger relationships as a result. 

To learn more about Nitrogen’s approach to mitigating portfolio risk, schedule a demo with our team today.