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4 ways to reduce investment risk

Key takeaways

  • Asset allocation and diversification have the potential to improve long-term returns while managing market ups and downs for the targeted level of risk.
  • If you feel there is too much stock market risk in your mix, one way to mitigate is by reducing the amount of stock and increasing the amount of bonds and short-term investments you own.
  • Professional investment management is available at every price point (even free in some cases). If monitoring investments is too stressful, consider getting help.
  • Invested in a diversified, time-horizon-appropriate mix? Besides periodically rebalancing, consider doing nothing. Sticking with your well-considered investment strategy for the long term can help you reach your goals.

Few investors enjoy stock market downturns. Green arrows turn red, and suddenly nearly everything goes down—and down, and down. But stocks fall with regular frequency. With a little forethought, you can plan for these times in your investing strategy.

"Stocks have gone up about 60% of the time," said Jurrien Timmer, head of global macro at Fidelity, in a recent episode of the Market Sense webcast. "That means they went down about 40% of the time."

For a variety of reasons, some investors aren't emotionally or financially able to stomach big swings in the value of their investment accounts. So when the market starts to go down, investors with a low tolerance for risk may want to sell out of investments and wait for the danger to pass. But being out of the market when it ultimately rebounds—often when you least expect it—can undermine your long-term performance potential.

To learn about risk tolerance, read Viewpoints on 3 keys to choosing investments

If you're tempted to get out of the market when it's down, consider these tips to deal with risk in your investment mix and stick with your plan for the long term.

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1. Asset allocation and diversification

There are time-tested strategies aimed at managing the risk of a broad market downturn: asset allocation and diversification. They won't ensure a profit or guarantee against loss, but do provide the potential to improve long-term returns while managing market ups and downs for the targeted level of risk.

Asset allocation refers to your mix of investment types. The main types of investments are generally stocks, bonds, and short-term investments like money market funds, but alternatives like commodities and real estate can also be used. Your asset allocation sets the level of stock market risk in your investment mix.

The practice of asset allocation helps you diversify across investment types, and that can help mitigate some of the stock market risk in your portfolio. Bonds and short-term investments tend to be less volatile than stocks, and including them in your investment mix can help smooth out the ride, dampening some of the wild swings up and down that stocks can deliver.

Diversification means investing in a broad range of investments across and within those broader classifications of stocks, bonds, and short-term investments. Ways to diversify in stocks include company size by market cap, industry, and geography for just a few examples. In bonds, you can diversify by type (government, corporate, and municipal), maturity, and other criteria.

Read Viewpoints on The guide to diversification

The chart below, Diversification can help smooth the ups and downs of your portfolio, shows an example from 2020 when stocks plunged dramatically for nearly 2 months. The S&P 500 Index fell further than a portfolio of 60% stocks and 40% bonds. On the other side, when stocks recovered, the index gained more ground more quickly than the 60/40 mix.

Diversification can help smooth the ups and downs of your portfolio

The 60/40 investment mix experienced less volatility than the S&P 500 Index®. Daily data. Source: FMRCo, Bloomberg, Haver Analytics, FactSet, S&P 500, and Barclays US aggregate. Data as of June 2021.

2. Reduce the amount of stock/increase bonds and short-term investments in your mix

If your investments keep you awake at night when volatility hits, shifting to a more conservative portfolio may make sense. In some cases, investors may be better served with a more conservative investment strategy—for instance, something may have changed in your life like your financial circumstances, your time frame, or your patience for the ups and downs of the market.

Let's say that you are a 35-year-old investing for retirement and your investment mix is 85% stocks and 15% bonds. For someone with decades until retirement, that could be appropriate, but you find it too harrowing. For some peace of mind, reducing the amount of stocks and/or increasing the amount of bonds or short-term investments could reduce some of the volatility you see in your account. That way you're still potentially benefiting from the growth stocks can provide but the exposure is limited to a smaller portion of your investment mix. By doing this, of course, you'd be trading the potential of higher returns for the potential of lower volatility.

The sample asset mixes shown in the graphic Choosing an investment mix, combine various amounts of stock, bond, and short-term investments to illustrate different levels of risk and return potential.

Choosing an investment mix

Data source: Fidelity Investments and Morningstar Inc. (1926–2022).* Past performance is no guarantee of future results. Returns include the reinvestment of dividends and other earnings. This chart is for illustrative purposes only. It is not possible to invest directly in an index. Time periods for best and worst returns are based on calendar year. For information on the indexes used to construct this table see Data Source in the notes below. The purpose of the target asset mixes is to show how target asset mixes may be created with different risk and return characteristics to help meet a participant's goals. You should choose your own investments based on your particular objectives and situation. Remember, you may change how your account is invested. Be sure to review your decisions periodically to make sure they are still consistent with your goals. You should also consider any investments you may have outside the plan when making your investment choices.

3. Let someone else handle the investing for you

Fidelity offers a range of mutual funds, ETFs, and managed accounts that can help you reach your goals. There are a range of options, from straightforward investment management to comprehensive planning for your full financial picture.

One investment strategy worth considering is a defensive approach. For risk-averse investors who struggle to stick with investments when the market drops, a defensive approach may help avoid selling early, locking in losses, and undermining their opportunity for longer-term portfolio growth. To read more about defensive investing, read Viewpoints on Seeking shelter in volatile markets

“For people who are retired and concerned about things like stability of principal or certainty of income, the guarantees inherent in different types of annuity products can provide an additional level of security and peace of mind, especially during periods of market volatility," says Jerry Patterson, president of Fidelity Investments Life Insurance Company.

Staying invested throughout retirement can be particularly important, as the growth potential from stocks can help ensure that your money lasts. Getting an objective opinion from an investment professional can help you understand where you stand and what to consider when economic conditions seem uncertain.

Read Viewpoints on Thinking of retiring into this market?

People who are still working could also benefit from a defensive approach if the prospect of a market downturn keeps them on the sidelines.

4. Consider doing nothing

People feel the pain of losses more acutely than they feel the joy of gains. So if you have a diversified, appropriate mix of investments that aligns with your time horizon and financial situation, besides periodically rebalancing your portfolio, it can make sense to just tune out the news and avoid the noise.

To meet your goals, a certain rate of return over time may be needed. Stocks have historically provided that growth potential.

Risk vs. reward

A successful investing strategy is a balancing act between risk and potential rewards. But the best strategy can only be as successful as the investor's ability to execute it. If your investments keep you up at night or if you know that a stock market downturn may prompt you to sell, you may need a different approach. After all, your investment strategy should be one that you'll be able to stick with. Ample research has found that selling investments with a plan to get back in the market once the tumult clears can often lead to suboptimal results. Losses that were only on paper get locked in and there's a high likelihood of missing the best days in the market which can hamstring long-term returns. If you're not sure how to build your own investment mix, consider connecting with a Fidelity financial professional for more help.

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This information is intended to be educational and is not tailored to the investment needs of any specific investor.

*Data Source: Fidelity Investments and Morningstar Inc. Hypothetical value of assets held in untaxed portfolios invested in US stocks, foreign stocks, bonds, or short-term investments. Historical returns and volatility of the stock, bond, and short-term asset classes are based on the historical performance data of various unmanaged indexes from 1926 through the latest year-end data available from Morningstar. Domestic stocks represented by IA SBBI US Large Stock TR USD Ext Jan 1926-Jan 1987, then by Dow Jones US Total Market data starting Feb 1987 to Present. Foreign stocks represented by IA SBBI US Large Stock TR USD Ext Jan 1926–Dec 1969, MSCI EAFE Jan 1970-Nov 2000, then MSCI ACWI Ex USA GR USD Dec 2000 to Present. Bonds represented by US Intermediate-Term Government Bond Index Jan 1926–Dec 1975, then Barclays Aggregate Bond Jan 1976 - Present. Short-term/cash represented by 30-day US Treasury bills beginning in Jan 1926 to Present. Past performance is no guarantee of future results. The purpose of the target asset mixes is to show how target asset mixes may be created with different risk and return characteristics to help meet an investor's goals. You should choose your own investments based on your particular objectives and situation. Be sure to review your decisions periodically to make sure they are still consistent with your goals.

Views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Unless otherwise noted, the opinions provided are those of the speaker or author and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information.

Past performance is no guarantee of future results.

Investing involves risk, including risk of loss.

Diversification and asset allocation do not ensure a profit or guarantee against loss.

Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risks, including the loss of principal.

In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities). Fixed income securities also carry inflation risk, liquidity risk, call risk and credit and default risks for both issuers and counterparties. Lower-quality fixed income securities involve greater risk of default or price changes due to potential changes in the credit quality of the issuer. Foreign investments involve greater risks than U.S. investments, and can decline significantly in response to adverse issuer, political, regulatory, market, and economic risks. Any fixed-income security sold or redeemed prior to maturity may be subject to loss.

Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.

The S&P 500® Index is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent US equity performance. The Bloomberg Barclays U.S. Aggregate Bond Index is an unmanaged market value-weighted index for U.S. dollar denominated investment-grade fixed-rate debt issues, including government, corporate, asset-backed, and mortgage-backed securities with maturities of at least one year.

All indexes are unmanaged, and performance of the indexes includes reinvestment of dividends and interest income, unless otherwise noted. Indexes are not illustrative of any particular investment, and it is not possible to invest directly in an index.

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