CHICAGO (Reuters) – If the fiscal cliff triggers an economic slowdown, you need to prepare your portfolio by lowering its risk profile. Even if you think you’re prepared, it’s good to take a detailed look at what you own.
Classic modern portfolio theory holds that diversification among stocks, bonds, real estate and other asset classes will balance the tenuous relationship between risk and return.
When the stock market tumbles 2 percent in a single day – as it did on November 7 – many pundits say that’s a sign of things to come if Congress doesn’t resolve the mother of all tax hikes by the end of the year.
The idea of tax increases and spending cuts amounting to $600 billion on January 1 is enough to instill markets with uncertainty, one of the greatest enemies of investors. Yet you can lose money if you react to every sell-off by jumping out of the market, so it makes sense to do a portfolio risk profile at least once a year. This will help buffer your portfolio against uncertainty risk.
A portfolio profile examines how asset classes react to volatility over time. What a portfolio profile is not is a knee-jerk reaction that allows you to time the market. To use it efficiently, you need a better understanding of risk.