Portfolio Risk & The Benefits Of A Portfolio Health Check

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Portfolio Risk & The Benefits Of A Portfolio Health Check

Table of Сontents

  1. Portfolio Risk Definition
  2. Types of Portfolio Investment Risks
  3. Analyzing Portfolio Risk: 5 Metrics to Measure Risk
  4. Portfolio Health Check
  5. How To Run a Portfolio Health Check
  6. Bottom Line


No matter how you feel, it’s a good idea to get a yearly physical from a doctor. A portfolio of investments is the same. Investors should assess their investments’ performance and potential risks on a regular basis. Find out more about the advantages of a portfolio health check and portfolio risk.

Portfolio Risk Definition

An indicator of an investment portfolio’s total risk is its portfolio risk. The mixture of several categories of risk, such as market, interest rate, and inflation risk, may be assessed using this metric. The risk tolerance of the investor and the returns necessary to meet the portfolio aim may also be taken into account in a portfolio risk analysis.

Personal Risk Tolerance & Goals

Risk analysis is primarily used to determine if an investor’s portfolio’s total risk is in line with their risk tolerance, time horizon, and financial objectives. For instance, a risk-averse investor hoping to retire in five years would not want to have a portfolio made up entirely of growth equities.

The following variables help determine the proper degree of portfolio health risk:


Risk tolerance: The amount of price volatility an investor is willing to take for an asset or portfolio. For instance, a trader who has a high-risk tolerance is ready to take on a lot of market danger in exchange for the chance to make more money.

Time horizon: the approximate number of years an investor will have to wait before they can start taking withdrawals from their investment accounts. The capacity to endure danger is often larger the longer the time horizon.

Financial goal: This is the main goal that the portfolio should achieve, whether it is income or growth. Savings for retirement or schooling may be specific objectives.

Portfolio Investment Risks & Return Risk and return often have a positive connection. The risk is larger when the possible return on investment is bigger. The ideal asset allocation, or combination of investment assets, will strike a balance between a reasonable level of risk and a return adequate to meet the investor’s financial objectives.

Important: Although risk and return are positively correlated, there is no assurance that taking on greater risk would eventually provide better returns. The risk starts at that point. It is a complicated indicator of financial risk that has several definitions.

Types of Portfolio Investment Risks

A person’s portfolio may include a variety of assets, including cash, bonds, and stocks. The objective is to achieve the returns required to meet portfolio objectives while maintaining suitable levels of risk for the investor. When building a portfolio, investors need to be aware of the many types of investment risks.

The most common categories of investing hazards are:

Market risk: This risk, sometimes referred to as systemic risk or non-diversifiable risk, is present throughout the whole market. For instance, the entire stock market may experience decreases during severe economic downturns, not simply a small portion of it.

Interest rate risk This risk refers to the possibility that a change in interest rates would have a detrimental effect on an asset’s price and is mostly related to fixed-income investments. For instance, falling bond prices are typically correlated with increasing interest rates.

Credit risk: This possibility of loss stemming from a borrower’s failure to make necessary payments to a lender is often referred to as default risk. When acquiring a bond, which functions as a loan to the issuing business, investors may be exposed to this risk. Rating firms provide credit ratings to investors.

Inflation risk: The risk that an unforeseen degree of inflation may lower the future value of an asset or cash flow is often referred to as purchasing power risk.

Currency risk: This risk, often known as exchange-rate risk, is what investors deal with when purchasing assets using a foreign currency. An investment security’s valuation may be impacted by changes in the relative value of several currencies.

Liquidity risk: Liquidity risk in investing refers to the possibility that security cannot be purchased or sold rapidly enough to avoid having an adverse effect on the security’s price. Real estate, collectibles, and private equity investments are illiquid asset types.

Political Risk: This is the danger that shifting political conditions may harm an investment. This risk may be present in both domestic and international investments, although it may be more important in developing market investments.

Analyzing Portfolio Risk: 5 Metrics to Measure Risk

Investors may employ a variety of portfolio health evaluation indicators when assessing and tracking the health of their portfolios. Although total return is a crucial performance indicator, it only provides a partial picture. Risk indicators, such as standard deviation, play an equally significant role.

5 metrics to measure portfolio risk are:

  1. Standard Deviation: a portfolio’s or investment’s level of volatility. A higher standard deviation, for instance, denotes greater price variance or volatility compared to average performance.
  2. Beta: compares the risk of an investment to a market benchmark. The market’s beta will always be 1.0. An investment is more volatile than the market if its beta value exceeds 1.0, and it is less volatile than the market if it is below 1.0.
  3. R-Squared: represents the changes in an investment’s price that correspond to changes in the benchmark index. R-squared may be stated as a percentage and can vary from 0% to 100%. An R-squared of 0.95, for instance, indicates that 95% of the price changes of the investment are connected with its benchmark.
  4. Sharpe Ratio: a risk-adjusted return metric that indicates the amount of volatility an investor must accept in order to get a return greater than that of a risk-free asset. This might aid an investor in determining if the higher risk associated with an asset or portfolio merits its return. One greater than 1.5 indicates an excellent Sharpe ratio.
  5. Sortino Ratio: This gauges an investment’s or portfolio’s risk-adjusted return using a modification of the Sharpe ratio. Sortino varies from Sharpe in that it solely takes downside risk into account.
  6. Note: This uses a modified version of the Sharpe ratio to measure the risk-adjusted return of an investment or portfolio. Sortino differs from Sharpe in that it only considers downside risk.

Portfolio Health Check

A portfolio health check uses a variety of risk and performance criteria to periodically assess the condition of an investment portfolio. A portfolio health check will contain specific metrics to make sure a portfolio continues to conform to portfolio objectives, much like a doctor monitoring a patient’s vital signs during an annual physical checkup.

Tip: To describe their investing approach, investors frequently draught an investment policy statement or IPS. Individual investors, professional money managers, and investment advisers can all utilize an IPS to describe their investment goals, objectives, and the metrics they’ll be using to gauge risk and performance.

How To Run a Portfolio Health Check

Although investors can pick from a variety of investment goals and tactics, most investors’ portfolio health checks can be broken down into the same broad categories. However, depending on an investor’s tastes and tactics, the precise methods to do a portfolio health check may differ.

Run a portfolio health check using these general procedures:

Step 1: Create an Investment Policy Statement

If a shareholder does not already have an investment policy statement (IPS), they can develop one by defining and formalizing the investment aim or goal as well as the rules for choosing, overseeing, and changing investments in the portfolio.

Step 2: Measure Performance

An investor may set out to surpass a major benchmark, such as the S&P 500 index, the yearly rate of inflation, or the average return of the stock market, in order to meet a certain rate of return need.

Step 3: Assess the Risk

Investors may check to see if the portfolio is sufficiently diversified among assets, such as stocks and bonds, that when combined might result in a specific degree of risk, or they may use statistical measurements, such as Standard Deviation or Beta.

Step 4: Create a Plan

As a consequence of the portfolio health check, it may be decided to add or replace investments, or it may be necessary to rebalance the portfolio, which may include purchasing or selling in order to get it back to its original target allocations.

Step 5: Implement the Plan

This would entail making investment purchases or sales in accordance with the strategy developed as a consequence of the portfolio check.

Step 6: Monitor the Plan

In order to make sure that the portfolio is still meeting the investor’s objectives and aims, portfolio management is a continuous activity that necessitates regular inspection.

Tip: Tools that give a portfolio’s quick score and breakdown are available from Seeking Alpha. The measures examined include EPS revisions, value, growth, profitability, and profitability momentum.

Bottom Line

An investor can use a portfolio health check to regularly review several variables to assist verify the portfolio is fulfilling the defined performance goals and risk measures. Since every investor may have various objectives and levels of risk tolerance, the processes involved in a portfolio health check may differ depending on the individual.

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