5 Steps to Take Your Investing to the Next Level

If you’re already investing, then you probably know some of the basic concepts. One of the first concepts many investors learn is risk tolerance. The idea is that taking more risk with your investments offers a greater potential for reward over time—although it also comes with more potential for losing money. When you first learn about this, it can be easy to focus on the idea that the more risk that you take, the more potential you have for reward.

But the reality is that risk and reward aren’t a one-to-one comparison. Another concept known as the “efficient frontier” helps to quantify the ideal mix of risk and reward—helping you to better diversify your investments.

The general idea is that your investments should be in the best position to capture the highest expected return for a defined level of risk. And at a certain point, adding more risk to an investment portfolio doesn’t proportionately increase the potential returns. The “efficient frontier” helps you determine the investment portfolio that may generate the return that you’ll need without taking additional, unnecessary risk.

This “efficient frontier” concept is a key tenet in Modern Portfolio Theory (MPT), a mathematical investment framework that helps investors optimize their portfolios’ risk and return by diversifying their investments. The theory was developed by a Nobel prize-winning economist.

As you’re ready to level up your investments, let’s make sure you’re taking the appropriate amount of risk to get you to the goals you’re trying to achieve—no more and no less. This is where a financial advisor can provide a great deal of value when helping to manage your investment portfolio. Your advisor will get to know you and ask the right questions to identify your goals and your tolerance for risk. The advisor will work with you to position your investments to offer the highest probability of future success while balancing risk and return.

Together you can adjust as years go by and you meet some of your goals in life. For example, if you plan to help children fund college or you plan to buy a second home, your ideal risk/return tradeoff will probably move. It will shift again as you get closer to retirement.

When you start investing, risk and reward often translate into a portfolio made up of US stocks and bonds. You may have started with a mutual fund (made up of stocks and bonds) through a plan sponsored by your employer. Perhaps you have already seen some thrilling highs and worrisome lows in your portfolio’s value. If so, you’ve seen that stocks are risky but offer strong potential for growth over time. High-quality bonds tend to be less risky than stocks, but the potential for growth is also lower.

As your investments grow, you may be able to add more value by increasing your focus on how you allocate your portfolio to different types of stocks and bonds as well as additional asset classes (like commodities or real estate). For example, commodities are tangible goods, such as energy or precious metals, that you can invest in, and they are often a unique way to diversify a portfolio and hedge against inflation. Real estate is exactly what it sounds like. In both cases, it’s possible to invest in these real assets without directly buying the assets themselves.

At Northwestern Mutual Wealth Management Company, we evaluate the appropriateness of various asset classes from the perspective of what role each investment plays as part of a broadly diversified portfolio. Our experts monitor performance and risk for individual holdings and the total portfolio. We consider factors such as:

• How will positions, managers and strategies work together and complement one another within the portfolio?

• What exposures or risk factors are we seeking to increase/decrease?

• What is our outlook for the future, and are portfolios positioned accordingly?

• Are all the pieces working together as expected?

When you’re just starting out with your investments, a few funds may be all you need. As time goes by, a slightly more active approach to investing can add value over time. Here’s how we approach it at Northwestern Mutual:

1. Strategic Asset Allocation. We build portfolios with baseline allocations to the different asset classes mentioned previously. The allocations are meant to provide an optimal balance of risk and reward over the long term, meaning that you’re taking an appropriate amount of risk for the expected return based on your situation.
2. Dynamic Overlay. While strategic asset allocation is rooted in long-term assumptions, in the short term, we may increase or decrease our strategic asset class target percentages based on factors like valuations, policy, the economy and market sentiment. This results in being underweight or overweight the various asset classes (relative to our strategic asset allocation) based on our 12- to 18-month outlook.

While nothing is certain with investments, this approach is designed to add value over the long term.

Rebalancing to maintain your original strategic asset allocation

You may have heard the term “rebalancing.” Whether you’re just maintaining a portfolio with an allocation of stocks and bonds or something a little more advanced like we described above, your portfolio can get out of whack over time.

For example, let’s say your strategic allocation was originally 70 percent stocks, 30 percent bonds. After a year of strong stock market performance, it’s possible the value of your stocks grew faster than the value of your bonds. Now your allocation is 80 percent stocks and 20 percent bonds. To rebalance your portfolio, you would sell 10 percent of your stocks and reinvest the money in bonds to return your portfolio to your original 70/30 allocation. This will keep you in line with the strategic asset allocation that is most appropriate given your goals and risk tolerance.

Rebalancing helps take the emotion out of buying and selling assets. It also helps investors sell high (when an asset class has grown as a percentage of your portfolio) and buy low (when an asset class now represents a lower percentage of your portfolio).

When you start investing, it can be easy to focus on the potential for big gains—which may be what leads some folks to try to pick a few hot stocks. But as you level up your investments, hopefully you’re starting to see the value of diversification that helps you balance risk and reward. This helps you protect your money while you work to grow it. That’s great because that view is often what separates more advanced investors from those who are just starting out. And while investments are great at helping you achieve certain financial goals, investments alone could leave you and your family vulnerable. You could be vulnerable to financial risks outside the potential of losing money in the stock market.

That’s why a comprehensive financial plan should include more than just investments. It should encompass your entire financial picture. This includes additional financial options that work with your investments and reinforce them. Financial products like life insurance and annuities can work alongside your investments to help you achieve your financial goals while also protecting you from risks that investments alone won’t. And they also can work together with your investments.

Research by EY confirms the benefit of a financial plan that coordinates investments with additional financial options. Their analysis shows that when you properly allocate your wealth across investments, permanent life insurance and deferred income annuities, you’re more likely to outperform strategies that emphasize investments alone over the long term. A comprehensive approach to planning can deliver growth, security and stability while providing more options for managing your wealth long term.

The key to an approach that uses financial tools beyond just investments is to ensure that you’re coordinating everything. For example, if you have significant cash value accumulation in a whole life insurance policy, you may be able to take more risk with your investments without adding risk to your overall financial picture. At Northwestern Mutual, our advisors know how to leverage these options together to help you reach your financial goals while also planning for key risks that could get in your way.

Markets inevitably have their ups and downs. During periods of market volatility, even seasoned investors sometimes feel the need to get out of the market to ride out the storm. As the value of your investments grows, a stock market decline can be even more difficult to watch. However, leveling up your investments means committing to sticking to your plan. Financial advisors work with you on a plan that assumes some market volatility. But the plan works only if you stick to it.

Investors who feel compelled to sell during times of volatility often rationalize the decision by convincing themselves that they will just get out for a short time and then will get back in when times seem better. Even if they miss a couple good days, they assume, it will all work out in the end. The data, however, tells a different story. Missing even just a few of the market’s best days can have a major impact on the value of your investments over time.

In fact, as shown below, our analysis from 2022 shows that missing just the 10 best days in the stock market over the prior 20 years would have tanked an investor’s portfolio. It would have returned almost 50 percent less compared with staying fully invested for all trading days.

Perhaps not surprisingly, working with a financial advisor improves your confidence about your finances. The Northwestern Mutual 2023 Planning & Progress study found that 75 percent of people who work with a financial advisor feel strongly or very strongly about their finances. The number falls to 47 percent for those who don’t work with an advisor.

Northwestern Mutual financial advisors use a disciplined approach to investing. We’ll help you grow your wealth over the long term and recognize the difference between short-term market “noise” and the need to adjust to changing opportunities and challenges.

Anyone can make money in the stock market when times are good. At Northwestern Mutual, our financial advisors are concerned with both growing and protecting your wealth. While others may focus only on investments, we include insurance for protection and guaranteed growth and annuities to help with guaranteed income in retirement. We take a broad view of your whole financial situation to be your co-pilot on the way to reaching your goals.

All investments carry some level of risk, including the potential loss of all money invested. No investment strategy can guarantee a profit or protect against loss.

The primary purpose of permanent life insurance is to provide a death benefit. Using permanent life insurance accumulated value to supplement retirement income will reduce the death benefit and may affect other aspects of the policy.