Wealth management is a critical concept. As you work, invest and earn money, it’s important to properly manage that money and the assets you buy with it. In doing so, you can grow your wealth over time, which sets the stage for financial stability and a comfortable retirement.
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But wealth management isn’t something you’ll typically learn in grade school. When you get started, you’ll realize there are risks to consider as you invest your hard-earned money for your future.
That’s where risk management comes in, but it’s a trade-off. Assets that offer less risk typically come with smaller returns. So how do you balance growth and protection in your wealth management strategy? Let’s dig in.
Understanding Growth-Centric and Protection-Centric Assets
Before considering how you can balance growth and risk in your portfolio, it’s important to understand the differences between the assets you’ll typically use to do so.
- Growth assets: These are assets like stocks that have the potential to produce significant returns for investors. On the other hand, growth assets don’t typically come with any guarantee that gains will take place. Moreover, these investments are often risky. For example, if a company you invest in falls into financial trouble, you can lose a significant portion of your investment — or even all of it.
- Protection assets: These are assets that either offer guaranteed returns or are known for price stability in tumultuous markets. For example, products like bonds and CDs offer investors a fixed rate of return. So, when you purchase or open one, you know exactly how much money you’ll earn over time. Other assets, like precious metals, don’t offer any guaranteed returns, but they tend to enjoy significant levels of price stability, making them popular safe-haven investments.
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A General Rule for Balancing Growth and Risk
Balancing growth and risk is based on the concept of asset allocation. If you’re a risk-averse investor, you’ll typically allocate more of your investment dollars to assets that offer low-risk returns. If you’re an investor with a healthy risk appetite, you’ll likely focus most of your investments on assets that have the potential to produce meaningful returns.
So how do you find the right balance between the two?
Doing so will likely take some time, but you can start with a simple rule of thumb. That rule is that you should use your age to determine your asset allocation, with the number of your age being your allocation to safe-haven investments.
For example, let’s say you’re 35 years old. In that case, you should allocate 35% of your investment dollars to assets that produce guaranteed returns or offer price stability, like bonds, CDs and precious metals. You’ll invest the other 65% of your investing dollars into assets that may come with more risk but have the potential to generate significant returns.
The core concept behind the strategy of focusing on your age is based on the fact that your risk appetite should shrink as you age. After all, if something goes wrong in your portfolio while you’re young and have multiple decades to make up for the mishap, it’s not as dire as it would be if things went wrong a year or two before retirement. As such, this strategy focuses on high growth at younger ages, high safety at older ages, and a steady balance between the two throughout.
Not Everyone’s Thumb Is the Same Size
Rules of thumb are great, and people tend to use them regularly in various aspects of life. But when you use a rule of thumb, it’s important to keep in mind that not everyone’s thumb is the same. When that rule relates to something as important as investing for your current and future financial stability, there’s a high probability that you’ll need to tweak the rule to fit your specific needs.
If you’re unsure of where to start when it comes to balancing growth and protection in your portfolio, start with the rule above, but be prepared to adjust. As your investments start to age, look into your returns and determine whether you’re meeting your goals. If you’re reaching your goals in terms of growth and you’re comfortable with the risk your portfolio possesses, you won’t need to change anything.
On the other hand, if you’re not quite hitting your growth goals and you’re comfortable taking on a bit more risk, you may want to shrink your safe-haven allocation and increase your growth allocation. If your growth is on track or beating expectations, but you’re concerned about the risk side of the portfolio, adjust your allocation to focus more of your investment dollars on safety.
Consider the State of the Market
It’s important to keep in mind that the market is cyclical. That means there are cycles of growth that are typically followed by cycles of decline. You should consider adjusting your strategy from time to time to account for market and economic conditions.
For example, if the economy is booming and the market is in a period of highly bullish performance, it may be wise to limit your safe-haven allocation while you focus more of your efforts on producing growth. On the other hand, if the economy isn’t quite as strong as it should be and you expect markets to react negatively, it may be time to adjust your allocation to limit your risk and put more of your money into safe-haven investments.
Always Be Ready To Adjust Your Strategy
No matter how much of your portfolio you decide to allocate to safe-haven investments or how much of it you decide to allocate to growth-centric investments, it’s important to be willing to adjust as you go.
The simple fact is that market conditions, economic conditions and geopolitical conditions will change as time passes. As they do, your risk tolerance and how you go about achieving growth should change as well.
Keep Tabs on the News
Finally, it’s important to keep a close eye on the news. In particular, watch for clues as to where the state of the economy is headed. After all, the news moves the market, so if reports show strong economic growth, the market is likely to head up. If reports show economic weakness, the market may react negatively. Always be ready to adjust your portfolio to match economic and market conditions.
Some news events to watch closely include:
- Jobs reports: The United States issues job reports regularly. Look for those reports and use them to determine the state of the economy. Keep in mind that when the economy is in good shape, it’s typically marked by strong jobs growth and minimal unemployment. If job numbers start to slump and unemployment grows, it could be a sign that economic conditions may degrade ahead.
- Federal Reserve: The Federal Reserve is charged with managing monetary policy in the U.S. In a nutshell, that means the central bank controls things like interest rates. That’s important because in high-rate cycles, consumers tend to spend less money, leading to lower profits for publicly traded corporations. As such, a higher allocation to safe-haven investments may be the best option during these times. On the other hand, consumers spend more when interest rates are low, typically bolstering corporate profits. So low rates may be a sign to dive into growth opportunities.
- Geopolitical conditions: Finally, it’s typically wise to keep an eye on the geopolitical stage. Geopolitical unrest can inhibit economic growth. When geopolitical conditions are positive, consider focusing more on growth. And when geopolitical conditions are negative, it may be time to lean into safe-haven investments.
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This article originally appeared on GOBankingRates.com: How To Balance Growth and Protection in Your Wealth Management Strategy
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
