Market risk — Riding those market ups and downs

When talk turns to investing and the subject of risk comes up, “market risk” is often the topic. Market risk is the chance that an investment will lose value. This can be caused by widespread economic changes or issues within specific industries or specific companies.

Generally, stocks and stock mutual funds have the most market risk because they tend to fluctuate in value more sharply than bonds or stable value investments. This higher level of risk is why stocks have historically offered higher returns. Investors should seek a comfortable balance between potential risk and potential return, and remember that past performance is no guarantee of future results.

Manage market risk with asset allocation

One of the best ways to help manage market risk is with asset allocation — the percentage of your money you put into different asset classes or investment types. Asset classes tend to perform differently from one another over time. Large cap stocks may perform best one year and the next year international stocks may be the best performer. Then the following year bonds might beat them all. Asset allocation has a greater impact on the performance of your overall portfolio than any other single factor. Keep in mind, asset allocation does not guarantee a market gain or protect against market losses in declining markets.

A properly allocated portfolio may help to balance out the investments that are doing poorly. Since your returns are an average of all the asset classes in your portfolio, asset allocation helps to level out the dramatic ups and downs of any particular category and may reduce your overall market risk.

Drill down with diversification

Diversification is another way you can help manage market risk. Diversifying your portfolio means spreading your investments (and spreading your risk) across multiple investments. This helps to reduce the impact a single investment has on your performance. For example, by diversifying across multiple stocks, you lessen the impact of a loss in any one company. Mutual funds provide automatic diversification because they invest in multiple securities — stocks, bonds or sometimes both.

Take advantage of market risk

When investing for retirement, you need to accept a certain amount of market risk if you want the growth potential that comes from investing in stocks. Although asset allocation and diversification cannot guarantee a profit or protect against loss, they are well-recognized risk management strategies that can help smooth out volatility.