Risk management & diversification: the portfolio revision

Regular investment portfolio reviews are a good way to make sure your investment choices remain in line with your plans, circumstances and risk appetite over the long term. Diversification plays a key role in investment risk management. 

As the war goes on in Ukraine, it’s reasonable to think about your investment portfolio and whether you need to take any action. Russia’s invasion has prompted significant volatility in markets and higher energy and agricultural prices could dent economic growth. However, it may be worth asking a broader question: when is the right time to review your portfolio?

Most financial advisers will say that investors should sit tight during periods of market volatility such as we’re in today. The logic behind this is sound: if you sell out at a time of crisis, you will crystallise your losses at the worst possible moment. It’s also very difficult to know when to reinvest. Cash might feel like a ‘safe’ option, but with savings rates still low and inflation running at 40-year highs, you could be losing money in real terms for each month you hold cash. The pandemic is an obvious example. Markets fell 30% in March 2020 over just a few days, but six months later had recovered all their lost ground. 

There was still no vaccine at that point and no reason to assume that the economy would improve. Investors who had sold out during the volatility would have realised a significant loss and then struggled to find the right point to reinvest.

However, there are certain exceptions where there could be a longer-term impact on assets. The war in Ukraine, for example, has changed the trajectory for certain assets, including those in Russia and other parts of emerging markets. It’s also likely to be more difficult for energy-intensive industries, such as airlines. Against this backdrop, you may want to take a closer look at the detail of your portfolio.

Many different factors can change your financial ambitions. The right portfolio when you are a footloose twenty-something may no longer fit when you have a raft of responsibilities – mortgages, children, dogs, elderly parents. Equally, the right portfolio for accumulating wealth may not be the right one when you are in retirement. You need to make sure you are taking the appropriate level of risk for your age, stage and appetite.

With that in mind, your portfolio and risk management may evolve over time. The general rule is that you can afford to take on more risk when you are younger, moving into lower risk assets later in life, but this isn’t universal. In general, it’s worth reviewing your portfolio whenever you undergo a major life change – from marriage, to buying your first home, to a significant promotion or redundancy. You may need to take a little less risk or a little more.

Your tastes may also change. You may become more concerned about environmental issues, for example, and want to make sure your portfolio reflects that. There is increasing choice available to investors who want to factor environmental, social or governance considerations into their investment selection.

It’s a good habit to review your portfolio at least once a year to make sure it’s balanced and positioned as you need it to be. If a certain part of your portfolio performs very well, it can start to take a disproportionate share. Over the past few years, this has happened with the technology sector, which has become a far larger share of the stock market indices. If your portfolio is skewed to a specific area, it’s important that you know and understand the risks.The most resilient portfolios tend to be well-diversified. 

That means they won’t hold significant exposure to any one region, sector or asset class. It’s always difficult to predict the twists and turns of markets, so being over-exposed in one area can leave you vulnerable. Most sectors have their day in the sun and their moment in the doldrums as part of the ongoing market cycle. Diversification should help smooth out these ups and downs.

American economist Harry Markowitz’ Modern Portfolio Theory says that the characteristics of each component of a portfolio shouldn’t be viewed in isolation, but for how they impact on a portfolio’s overall risk and return. It is possible to construct a portfolio where the overall balance of risk and return is greater than the sum of its parts.

With Fineco you can diversify across direct investment in stocks and shares and through collective investment funds. You can invest in the markets instead of gaming them with fads or trends, with thousands of investment options to choose from and no hidden fees.