What is Downside Risk? Most people aren't tossing and turning at night over why their retirement account is only raking in annual returns of just 5%. According to a number of studies, what fuels an investor's sleepless nights (and their investment decisions) is the fear of negative returns. In fact a British study found that the experience of losing money—or even the anticipation of a financial loss—is processed by the brain in a similar fashion to physical pain. That's why it's so important to consider downside risk when constructing the investment strategy for your retirement account. Basically, downside risk is the degree of losses you could potentially sustain if market conditions deteriorate. What drives downside risk is the aggressiveness of your portfolio, which is generally determined by how much of your account is allocated to stocks (all investments carry risk, though stocks tend to be riskier than bonds and cash). The greater the allocation to stocks, the higher the risk, and thus the more exposed you are to losses (as well as the wider the variance of your returns). The flip side, however, is that the more aggressive your portfolio, the greater your potential for gains. There are three things you can do to help minimize downside risk: 1. Diversify Your Portfolio The first is to ensure that you have the right allocation among stocks, bonds, and cash. The more stocks in your portfolio, the riskier it is. By incrementally adding bonds and cash, you can help reduce that risk. The tradeoff, as you can see in the chart below, is that that by reducing your downside risk you also diminish your potential for gains. Your goal is to find a comfortable balance. You should consider a number of factors when determining that balance—your age, time horizon to retirement, risk tolerance level, and your account balance, to name just a few.								> Home > Glossary > Support Questions & Answers   How can you minimize your downside risk exposure?   Reduce the amount of bonds in your portfolio   Increase your contribution rate   Reduce exposure to riskier equity sectors

		2. Reduce Sector Concentration The second is to ensure that your allocation within stocks is well-diversified within sectors. It is important not to be overweight in one area or sector of the market. Some equity funds—such as small cap stocks and emerging market stocks—are riskier than others (use the “Investment Research” link at the bottom of each page of Morningstar Retirement Manager to get detailed information—including sector exposure—on each fund in your plan's lineup) So although you might have the right mix of stocks, cash, and bonds in your portfolio, you might be too heavily allocated to one type of stock or sector, such as telecommunications or energy. That could significantly increase your downside risk exposure. 3. Rebalance Your Portfolio Third, you need to rebalance your portfolio once or twice a year. Over time, as certain investments outperform others, your portfolio will shift out of balance. As a result, it can become too heavily concentrated in one specific asset class and your downside risk can slowly increase. You rebalance a portfolio by selling off some of the funds that have done well to buy more of the funds that haven't done well. The links below include more in-depth articles on how to rebalance. As you try to find the right asset mix for your nest egg, you should keep in mind that your objective shouldn't be to make money just for the sake of making it. Most advisors will recommend that you assume no more risk than is needed to reach your specific retirement income goal. That's why it is so important to determine what you will need in retirement before setting your strategy. In some cases, participants who enter our service with either highly concentrated portfolios or overly aggressive portfolios may see a slight drop in their projected Retirement Income Outlook with our proposed strategy. That's because our strategy tries to minimize the potential losses you could sustain in a down market.

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> The Tradeoff Between Investment Risk and Return: Risky Business > Different Types of Risk > How to Measure Risk > The Greatest Risk of All > Who Can Take a Lot of Risk? > Reducing Your Risk > Tips for Getting Diversified > Diversification: Many Eggs, Many Baskets > What Is An Appropriate Amount of Diversification? > Diversifying With Individual Investments > Diversifying through Asset Mixes

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