Getting a Handle on Risk

At its root, risk is the chance of losing money, but it can take many different forms. Some of the most common types of risk are market risk (or the chance that the entire market will decline), sector or industry risk (the odds that a given sector will go out of favor), valuation risk (the chance that an overpriced security will see its price drop), concentration risk (the risk caused by having too much exposure to a particular stock, style, or sector), and the risk that your investments won't keep pace with inflation or grow enough to meet your long-term financial goals.

The first step toward getting a handle on your portfolio's risk profile is carefully examining all of your holdings.

Action Plan
In the action plan below, we'll show you how to understand your portfolio's risk profile and make any necessary adjustments.

1) First, look at the risk profile of your individual stock and mutual fund holdings. If you haven't saved your portfolio on Morningstar.com already, you can easily do so within the Instant X-Ray tool.

Simply enter the ticker and dollar value for each of your mutual fund and stock holdings.

2) To see each fund holding's risk profile, first click on the "Show Instant X-Ray" tab, and then find your top holdings at the bottom of the screen. Click on the fund name to see its Fund Report; then click on the "Ratings" tab to see a variety of statistics on historical risk. Morningstar Risk describes how the fund's risk level compares with other funds in the same category. To compare funds across categories, check out the standard deviation, under the "Risk Measures" tab on the left side of the page. (The norm for the S&P 500 has been about 16.18% over the past three years.) Our Bear Market Decile Rank homes in on how the fund has fared in bear-market months over the trailing five years. Decile ranks are assigned from 1 to 10, with the best funds ranking 1 and the worst ranking 10.

3) To see how risky your stock holdings have been, return to your Instant X-Ray View and click on the stock name to see its Stock Report. The performance graph and annual-returns section on the Company Snapshot page (located under the "Snapshot" tab) give a quick summary of the stock's past performance. You can get more details on the stock's historical volatility by clicking on the "Charts & Returns" tab on the left side of the page. To get a handle on potential future risks, look at the Morningstar Stock Grades for Growth, Profitability, and Financial Health. (Stock Grades are located under the "Snapshot" tab.) For Financial Health in particular, a below-average grade probably means the company is taking on business risk.

Our analysts also make qualitative assessments of each company's level of business risk by evaluating several different risk factors. This is a feature of Morningstar's Premium Membership, but you can access the stock risk ratings by signing up for a free trial. Click here to start.

4) To look at your portfolio's overall risk level, go back to the Instant X-Ray View. You can see your portfolio's diversification by asset class, style box, stock sector, and stock type. A big concentration in any area probably means more risk. Also on this page, you'll see how your portfolio's price/earnings and price/book ratios compare with those of the S&P 500. If they're above average, you're taking on extra valuation risk.

5) Risk Analyzer: This tool, which is another benefit of Premium Membership, allows you to make a more-sophisticated risk assessment. 

With Risk Analyzer, you can test the probability of losing a certain amount of money over a given time period and see how adding or cutting holdings from your portfolio would affect the level of risk. To access the Risk Analyzer tool, sign up for a Premium trial.

Learn More: Readings
"Factoring in Risk in Valuation", by Brian Lund

"Don't Overlook Risks in Top Foreign Funds", by William Samuel Rocco

"Finding Solid Funds to Anchor Your Portfolio", by Emily Hall

"Why You Need a Margin of Safety", by David Kathman

"Getting a Grip on Beta", by Jeremy Lopez

Remember, risk is an inherent part of investing. But getting a better handle on your portfolmake io's risk profile can help you sure you're not taking on more risk than you bargained for.