Understanding Risk Management Techniques: Protecting Your Portfolio in Times of Uncertainty

Portfolio risk can have a few different meanings, but the one we will review today is the risk that an investor’s portfolio could lose money. Different investors will have differing levels of risk tolerance.  

Portfolio Diversification  

Portfolio diversification is about investing across a range of investments and investment types. The idea is that different types of investments react differently to similar economic and market conditions. Having an appropriate mix of various types of investments can help minimize losses in your portfolio in that generally some portion of your portfolio will do well across the full range of market conditions.  

The correlation between different types of investments is a key element of diversification. For example, according to Morningstar1, the correlation between U.S, large cap growth stocks and the following asset classes is:  

  • U.S. small cap value stocks 71.8% 
  • Foreign industrialized markets stocks 51.7% 
  • U.S. investment grade bonds 18.9% 
  • Cash 2.3% 
  • Commodities 12.4% 

What these percentages signify is the percentage of the price movements in securities in these asset classes are tied to the movement of process for U.S. large cap growth stocks. While the correlation with U.S. small cap value stocks is fairly high at 71.8%, the correlation with cash is ultra-low at 2.3%. Essentially, these two asset classes have virtually no correlation with each other.  

In the case of cash, which could be represented by a savings account, CDs, or a money market account, this makes total sense, as cash is considered the ultimate safe haven asset during periods of stock market volatility.  

Asset Allocation  

Asset allocation is the next step in portfolio diversification. A formal asset allocation strategy will set target allocations for various asset classes such as stocks, bonds, cash, alternatives and others. Beyond these broad asset classes, your allocation will generally be more granular with sub-asset classes such as large, small and mid-cap stocks, foreign stocks as well as stocks that are value- or growth-oriented. 

This sub-asset class approach also holds true with bonds and other types of investments.  

A famous study by Gary Brinson attributed 90% of the performance of an investment portfolio to its asset allocation.2 Over the years, other studies have attributed more or less of the percentage of a portfolio’s return to asset allocation, but the percentage is still a high one.  

Your asset allocation should be an outgrowth of your overall financial planning objectives and strategies. The allocation should be based on your age, your risk tolerance, and your time horizon for the use(s) of the money.  

Generally, you will want to look at your asset allocation on any overall basis across the various accounts you may have, including taxable accounts or retirement accounts like an IRA or a 401(k). However, it can make sense to have slightly different asset allocations for different accounts if they will be tapped for income at various times for different purposes.  

Portfolio Rebalancing  

Portfolio rebalancing involves periodically adjusting the level of the various holdings in your portfolio to ensure that your overall portfolio asset allocation is in line with your target asset allocation. This may involve selling some holdings and using the proceeds to purchase securities in asset classes that are underweight.  

Another rebalancing tactic is to direct new money that you add to one or more accounts into holdings in those underweight asset classes. Giving shares of appreciated securities to a charity or adding them to a donor advised fund is another way to rebalance. For those who can itemize on their taxes, this offers a tax deduction. In addition, you will not be subject to any capital gains taxes that would arise if you had sold the shares outright.    

Portfolio rebalancing should be done on a regular basis, but not too frequently. Annually, semi-annually or quarterly might be appropriate, but daily or weekly would generally not be. When rebalancing you should consider the tax implications of shares being sold, both for gains and losses, if the shares are in a taxable account. Tax-loss harvesting, or using realized losses on shares to offset realized gains elsewhere in your portfolio, is a good consideration. Another consideration for rebalancing is to look at which accounts (taxable or tax-advantaged) to use for these transactions.  


While most of us invest to grow the value of our assets, our desire for growth needs to be balanced against the need to protect our investments against downside risk. It takes time to regain the former level of our investments after a down year for the markets.  

Contact your Wedbush financial advisor to discuss achieving the right balance between upside growth potential and the proper level of risk management for your portfolio. 

1Morningstar: https://admainnew.morningstar.com/webhelp/Practice/Plans/Correlation_Matrix_of_the_14_Asset_Classes.htm 

The information provided in the link above are an example of the average diversified portfolio at a certain point in time. The data should not be used to predict or estimate or mimic changes, but interpreted as a generic overview of what an average diversification looks like. That example of diversification might not suitable for everyone. Please discuss with your advisor what is suitable in your circumstances. The data provide from companies, and organizations that may be referenced on this page are not affiliated with Wedbush Securities or any of its affiliates. Opinions mentioned are that of the third-party and not of Wedbush Securities, the financial adviser and/registered representative, or any of our affiliates. 

2Gary P. Brinson, L. Randolph Hood, & Gilbert L. Beebower. (1986). Determinants of Portfolio Performance. Financial Analysts Journal, 42(4), 39–44. http://www.jstor.org/stable/4478947 




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These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information presented is not intended to constitute an investment recommendation for, or advice to, any specific person. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. The information in these materials may change at any time and without notice. 

Investment products involve investment risks including potential loss and are not insured by any federal agency, are not deposits or obligations of, or guaranteed by any financial institution and may involve loss of value. Past performance is never a guarantee of future returns.  

Investing in foreign stock markets involves additional risks, such as the risk of currency fluctuations. 

Rollovers of qualified plan assets is not your only option. Prior to deciding whether to keep an existing plan, or roll assets into an IRA, be sure to consider potential benefits and limitations of all options and discuss rollover options with your tax advisor.   

You can request a mutual fund prospectus by contacting your Wedbush Financial Adviser and/or Registered Representative. Before investing in a mutual fund or ETF, consider the investment objectives, risks, charges, and expenses. Past performance is no guarantee of future results. Diversification and asset allocation do not ensure a profit or guarantee against loss. Principal invested is not guaranteed.