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Managing risk in portfolio allocation

Managing risk in portfolio allocation

June 01, 2022

Managing risk is at the core of what we do for our clients. Portfolio design and management addresses the investor’s unique investment needs and yet also aligns with their specific risk tolerance.

As investment managers, we attempt to allocate a portfolio that balances the most reward with the risk level our clients are comfortable with. This is known as the efficient frontier. The efficient frontier is a set of portfolios that offer the highest expected return for a defined level of risk. This theory was first introduced in 1952 by Nobel Laureate and American economist Harry Markowitz. The theory assumes that investors prefer the most possible return with the least amount of risk. The efficient frontier portfolios are called ‘optimal’ portfolios because they have the optimal combination of risk and return. The theory also concludes that simply adding more risk does not gain an equal return and optimal portfolios tend to be more diversified.

Diversified Allocation Alignment

Harry Markowitz also pioneered the Modern Portfolio Theory (MPT), a method to construct diversified portfolios to maximize the return without taking on too much risk in the portfolio. This approach evaluates not only the investment’s risk and return but includes how the investment will affect the overall portfolio’s risk and return. MPT is a valuable approach for investors who want to own a diversified portfolio.

At Capital Financial Solutions, we align the client’s selected amount of risk with an appropriate allocation of products. A mix of various assets produces different levels of return and risk. These diversified products could include exchange-traded funds (ETFs), closed-end mutual funds, mutual funds, or a mix of all of these.  We focus on products with long-tenured managers who have demonstrated historical returns at or above other similar products at the most efficient cost.  We also utilize ratings by Morningstar, a highly regarded investment research firm, in our evaluations.  

Some steps in evaluating risk vs. return:

Want an evaluation of how diversified your portfolio is?

We can guide you through a detailed financial analysis process to help you plan for your retirement, investment, and savings goals. Set up a consultation to gain insight into how your risk and reward are balanced.

Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns. A diversified portfolio does not assure a profit or protect against loss in a declining market.

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