In my practice here at Potomac Wealth Strategies, clients' risk profile is determined first, then investments are selected and managed. Investment risk management helps us pursue growth of our portfolio while avoiding more risk than we can handle or pursuing gains we really need but knowing what the downside might feel like. It is mostly about diversification across various types of investments, or "asset classes". We don’t want all our eggs in one basket, and one's risk profile guides on how many eggs into which baskets. There is even Nobel Prize-winning research on how to diversify across asset classes in order to balance risk and reward. Read on for more about how I invest prudently for my clients.
The main asset classes are Stocks, Bonds, Cash, and Alternatives:
- Stocks are shares of ownership in publicly-traded companies.
- Bonds are basically loans to companies or municipal authorities or state/federal governments.
- Cash is the safest, either FDIC-insured bank deposits or non-insured but super safe Money Market Funds.
- Alternatives are investments in commodities, commercial real estate, and complicated risk-management or growth strategies.
Stocks have more risk/reward potential, cash has the least, bonds are relatively low, and alternatives are a mix of risk/reward potential.
To invest in and have exposure to the asset classes, I use investment products called mutual funds. They are a great tool for most investors, as they offer professional stock- and bond-picking expertise and diversification. Mutual funds are large portfolios run by managers who pool numerous investors’ cash and invest it according to a specific system the manager(s) decide on in advance. Almost anyone can invest in a mutual fund, and each investor owns shares proportionate to their investment in the fund. Each fund has a share price, like a stock does, that is calculated once-a-day or constantly throughout the trading day. There are mutual funds for stocks, for bonds, for cash (money market funds), and for alternatives (I usually use a real estate fund and a gold price-tracking fund in my portfolios, for the Alternatives space). All the funds I use for clients are traded publicly and can be bought or sold during any market trading day.
A typical portfolio model for PWS' clients has around a dozen mutual funds. Large USA stocks, small foreign stocks, low-risk bonds that pay a little interest, higher risk bonds that pay more interest, and so forth. Like a sports team with a game plan and many players on the field to execute the game plan, our portfolios need a plan (your risk profile and the portfolio model best-suited for it) and players... the mutual funds are the players, and I carefully select them to ensure we have the best available for each "position" on the "team".
Please contact me with any questions about mutual funds, asset allocation, or portfolio risk management.