When you say the word risk, most people conjure up thoughts of uncomfortable
and even terrifying consequences. Risk of disease, risk of layoffs, risk of
a plane crash. Ugh! We simply don’t want to go there. And when the word risk
is used in conjunction with our financial plan, most people really want to
run fast and far. But, is risk, fundamentally that damaging to our
investment portfolio? Properly used, it is not. In fact, I can prove to you
that in most situations, it can be a very good thing.
Over the past forty years, investment analysts and academicians have pooled
their research into the study of investment fundamentals under the term
Modern Portfolio Theory. Along the way, two Nobel Prizes in Economic Science
were won by these researchers. One of the dynamics they learned, as
counter-intuitive as it might seem, is that a portfolio that contains asset
classes (stocks, bonds, cash, international funds, etc.) that are otherwise
considered to be risky, actually can make the return and overall risk of
that portfolio substantially less risky.
For example, if you are investing in a 401(k), or variable insurance
product, you might think that investing in certain mutual funds such as
emerging growth, small company funds, or natural resources might be too
risky for your temperament. After all, the historical performance of these
funds – measured by themselves – will show considerably more volatility than
bond funds, large company stocks, or money market fund. However, if you
combine various asset classes (funds) that behave differently, regardless of
the volatility of any single fund, the overall return might be less risky
than the bond, or large company fund you otherwise would have invested in.
In layman’s terms it could be said that applying Modern Portfolio Theory can
help smooth out the volatility in the long run while enhancing investment
performance.
So, how do you find out how to take advantage of this Nobel Prize winning
investment management technology, ask your financial advisor, or log ontowww.MoneyAndValues. com. You won’t be able to “do it yourself”, but the
results just might let you live well and sleep well at the same time.
Stephen R. Bolt is the author of the book Money for Life, and Your Money,
Your Values. To learn more about values-based financial planning log onto MoneyAndValues.
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