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Are Your Funds Riskier Than You Think?

Most people can pick a few good funds, and as long as the market’s going up, their choices often seem to work out well.

But when the market eventually turns, these investors may discover that their funds were more volatile than they’d expected.

That’s what one fund investor discovered when the market sold off sharply.

She anticipated stock market volatility, but she thought her funds would hold up better than the market.

“I own 10 funds,” she said. “Shouldn’t that help in down markets?”

Think about the diversification of the funds you own

Owning a number of funds is one way to diversify your portfolio, but it’s also important to think about the kinds of funds you own.

If you invest in concentrated stock funds and sector funds, you are likely going to experience more highs and lows than an investor who owns only diversified stock funds.

The woman we spoke with owned mostly aggressive stock funds. Seven of her 10 funds were focused on a single sector or a particular industry, and these funds are more volatile than the broad market.

Review your portfolio periodically

Even with a diversified fund portfolio, it can be difficult to stay invested through the normal ups and downs of the market, and it’s often harder to stay on course with a portfolio of aggressive funds. That’s why it’s important to periodically review your fund portfolio and make sure your funds are in line with your expectations.

It’s worth double-checking your portfolio, even if you work with an advisor. We met with an investor recently who thought that his advisor had invested his assets in a conservative portfolio of stock and bond funds. He was surprised to learn that his portfolio was almost entirely invested in stock funds.   

Here are four things to look for:
1. Review your allocation to stock and bond funds

The first step is to figure out how much you’re currently invested in stock funds and how much is in bond funds. Is this mix still right for you, or do you need to make some changes?

Your allocation will change over time, and it may be time to rebalance. This is one way that you can avoid taking more risk than you’d intended.

2. Take a closer look at your stock funds

Are you invested mostly in diversified stock funds or speculative stock funds? Ideally, the majority (if not all) of your growth portfolio will be invested in core diversified stock funds that have about market-level risk, and you’ll have limited exposure to more concentrated funds.

3. Keep your position sizes in line

See how much you have invested in particular funds. If you have a large position in a sector fund, and that sector takes a dive, it could really affect your portfolio. In the fund portfolios we manage, we take larger positions in core diversified funds and smaller positions in sector or single-country funds.

4. Use bond funds as a buffer against stock market volatility

Bonds are an important cushion against the volatility of stocks, and they can help you stay invested in stocks long term. Bond funds give you far greater diversification than individual bonds, and that can help manage risk. Funds also give you access to areas of the bond market that are holding up better as rates rise, like high-yield bonds and floating-rate securities. As with equities, make sure you diversify your bond exposure. 

A version of this post originally appeared on Forbes.