How to reduce risk in your portfolio

Rebalancing your portfolio

When you first start creating your portfolio based on your risk tolerance, you will often have an asset allocation in mind. For example, someone comfortable with a moderate amount of risk might strive to achieve a balanced portfolio that often has a 60% allocation to equities and a 40% allocation to fixed income. As markets shift, your asset allocation within your portfolio will shift as well. For example, if the stock market has performed well over the years or if you’ve continued to invest regularly in one asset class, that 60/40 allocation of equities and fixed income might end up closer to 70/30. Rebalancing means selling some equities and taking those profits to buy more fixed income investments so that your portfolio gets back to that original 60/40 allocation that matches your risk tolerance. Unless you’re using a single asset allocation fund for your portfolio that automatically rebalances for you, this is likely something that you will have to do yourself.

Investors tend to look more closely at their portfolio during down markets, but It’s a good idea to rebalance your portfolio regularly regardless of market conditions.

Changing portfolio exposure

Every year a new asset class, sector or company will outperform the market and receive a lot of attention from media and investors alike. In the latest bull market, technology companies like Facebook, Apple, Netflix and Google (dubbed the FANG stocks) were big winners and more recently, the “meme” stocks of Gamestop, AMC and Blackberry saw huge price increases over a short period of time. Investors are likely to jump on these trends and those who time it right may see large gains that can have a big impact on their portfolio.

If you’ve enjoyed exceptional gains in a single few stocks or a hot sector, your portfolio may be exposed to concentration risk by being overweight in that area. If the weighting of a specific sector or stock makes up a large part of your portfolio, it may be smart to lock in those gains and reduce your exposure to that sector so that your portfolio is more balanced. Alternatively, you may want to increase your exposure to other industries that may provide a benefit in new market environments.

Using PortfolioScore^TM to help reduce risk

All Qtraders have free access to PortfolioScore, as part of Qtrade’s suite of Portfolio Analytics tools.  Looking at your Portfolio Score and is a great place to start if you are looking to make changes to your portfolio’s risk exposure. You can click into your score (graded from A-F) and use the tool to do a deeper dive into the five dimensions that your portfolio is graded on: Performance, Downside Protection, Fees, Income and Diversification. 

Downside protection
During down markets, your portfolio will likely also suffer some losses, but some portfolios may be prone to losing more than market benchmarks. Your portfolio’s downside score is an evaluation of your portfolio's ability to limit losses when there is a stock market downturn. It uses the standard deviation of your portfolio's historical returns to measure its total risk, reporting it as an annualized percentage for easy comparison. The higher the score the better, so if your portfolio isn’t scoring well on this dimension you may want to consider investing in some assets that aren’t correlated to the stock market like bonds, commodities or alternative funds.

Fees
There are many things that you ultimately cannot control when investing, but the fees that you are paying on your investments is one thing you can control. The Fees score measures your portfolio's average Management Expense Ratio (MER), an annual fee that you pay when you invest in a mutual fund or exchange-traded fund (ETF). These fees help cover the costs of investment managers, operating expenses, taxes and more. The lower your average MER is, the higher your overall fees score will be. Due to increasing competition between fund providers, there are always new products coming to market with more competitive fees. Taking the time to do some extra research and picking lower cost investing products that meet your investment objectives can help your long-term returns.

Income
Income refers to cash dividends from a stock, or cash distributions from an ETF or a mutual fund.  Many investors are focused on growing their portfolio by seeing the value of their investments increase, rather than providing income. Whether you want a high income score depends on your investing objective. If you are investing for the long-term, or if you are not dependent on your portfolio for everyday expenses, a high-income portfolio may not necessary. However, in more difficult market environments, having a portfolio that generates income can help you hold onto those investments through volatility.

Diversification
The most important thing that investors over-look is the value of having a truly diversified portfolio. That doesn’t just mean being diversified by asset classes, but also being globally diversified. A more diversified portfolio can help you minimize your portfolio's risk without sacrificing returns. This scoring tool is robust and you can see a breakdown of your average correlation across asset class, geography, sector and macroeconomic factors. Each of these dimensions can help illustrate where your portfolio could benefit from greater diversification.

Your performance vs benchmark

Ultimately, the most important thing investors care about is how their portfolio performs, but it’s important to put that performance into context. The performance score uses your annualized return and compares how it has performed relative to key benchmarks. It also shows some common ratios used by investment professionals like your portfolios Sharpe Ratio, Roy's Safety-First Criterion and Sortino Ratio, which are different metrics that quantify your portfolios risk to reward ratio. The higher your ratios are relative to the benchmark, the better. 

Using PortfolioSimulator^TM to test new ideas

If you feel that your portfolio needs to be adjusted after looking at the different grades that PortfolioScore has provided, you can use PortfolioSimulator to put those ideas to the test. Create a simulated portfolio to see how it compares with your current portfolio. A simulated portfolio lets you add, remove or change the weight of your holdings without affecting your actual portfolio. So, you can see how potential changes could affect your grading. You can also save your simulated portfolio to continually monitor or re-visit later.