Often when I meet with prospective clients to review their retirement holdings, their portfolio’s risk is measured in a ratio of equities-to-fixed income investments. This has been the traditional way to measure the overall risk of a portfolio, with the weight moving from the equity side to the fixed side as a client ages.
While this may be a simplified way of expressing risk, it may also be just that—too simple. I would make this argument for 2 reasons:
• Some bonds may be more risky that some stocks. It stands to reason that a debt instrument from an emerging market company could conceivably have more risk than an established dividend paying equity investement in the US domestic market
• Risk Changes over time. Volatility in the Emerging Markets asset class certainly is different today than it was 10 years ago, just as the risk of Real Estate or commodities has been an evolving factor over the last couple of years
To account for the changing risk levels regular and consistent analysis should be conducted. This process results in portfolios designed to take advantage of more attractive opportunities for investment while maintaining risk levels established by the analysis. It also allows for a portfolio to adapt as risk changes—of particular value when volatility spikes in the market for the pre-retiree investor.
A portfolio’s stock-to-bond ratio is greatly affected by whether the risk in a portfolio comes from a small allocation to emerging markets, a sizable allocation to high-yield bonds, or a moderate overweight of the equity allocation. However, an adaptive risk analysis can measure these options and determine to what degree a client’s risk tolerance can handle each.