Keep Watch over your Investments

Risk can creep up on even vigilant investors. For instance, your holdings in a retirement plan may grow more quickly than you realize, particularly if you make regular contributions or reinvest your returns. But along with this success comes a problem. Growth in one asset can throw your portfolio out of balance if other investments don't keep up. If a prolonged bull market boosts the value of your stockholdings, you may need to sell some shares to restore the balance between stocks and other assets. Similarly, when a single stock does extremely well, you might need to twist your own arm in order to bring yourself to unload some shares. And be especially wary of loading up on your employer's company stock through retirement and savings plans. If the company runs into difficulties, both your job and your stock could be endangered at the same time. Furthermore, if you live in a very small one-company town, the value of your home could also be indirectly tied to the fortunes of that organization. So keep a watchful eye on changes in your own investment portfolio. Carefully scrutinize your investments and other aspects of your finances from time to time. Here's a rundown of the strengths and weaknesses of some types of assets:

Stocks are vulnerable to the possibility that nervous investors will panic for some reason and drive share prices down as a whole – an example of market risk. But risks related to inflation, interest rates or economic growth might vary considerably from one stock to another. For example, a sharp increase in the rate of inflation could drive stock prices down by reducing the purchasing power of future shareholder dividends. Additionally, inflation generally travels with higher interest rates, which tend to draw investors from stocks into bonds. Because firms such as retailers, consumer product manufacturers and service companies can pass cost increases along to customers with relative ease, they're typically more likely to prosper during periods of high inflation.

On the other hand, slowing economic growth can hurt some businesses more than others. For instance, manufacturing companies that have high overhead costs can't easily cut their expenses when a recession reduces sales, so their earnings quickly fall off. Many emerging growth companies also require an expanding economy to sustain their earnings growth and stock prices. In contrast, however, firms that sell staple necessities such as food or clothing often continue to operate largely unaffected in a weak economy, and their shares tend to hold their value relatively well.

Stocks also carry specific risks – those that are unique to a single company or industry. Poor management, for example, can have a dramatically negative effect on earnings, even to the point of bankrupting a business. And growth stocks are particularly vulnerable to projected earnings shortfalls. One way to reduce such risks is to buy shares that appear to be undervalued because they're selling at comparatively low price-to-earnings (P/E) ratios.

Bond prices fall when interest rates rise. But the extent of a particular bond's drop depends upon its maturity and the amount of its coupon (the bond's stated interest rate). Short-term bonds fall slightly when interest rates move upward, and a high coupon also offers a degree of protection against climbing rates. Zero-coupon bonds, on the other hand, fall sharply when rates move higher.

A recession generally brings with it lower interest rates, which boost bond prices. But some bond issues react negatively to an economic downturn. Junk bonds, in particular, may suffer because investors fear that financially weak companies will default and fail to make their scheduled payments to bondholders on time. U.S. Treasury and high-grade corporate bonds gain the most during hard times because income investors often flock to them as safe havens.

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