Managing Risk Becomes More Important in 2025

Key Takeaways:
  • Keep a close eye on your portfolio’s balance, especially if your tech holdings have grown beyond your comfort level.
  • Plan for more modest returns this year by trimming risk where needed and exploring tax-efficient strategies like individual municipal bonds.
  • Don’t go too conservative too soon—longer lifespans mean you’ll likely need both growth and stability in your retirement investments.

 

Investing is a journey that evolves over time, and balancing growth and risk in your portfolio is important to achieving long-term financial goals. Achieving balance requires attention to many factors, including the direction of the investment markets, the changing political and social landscape and likely changes to tax law.

The beginning of a new year is a good time to take stock of where your portfolio is and where it should be going.

Managing risk will be an important theme in 2025. We’ve just emerged from two very lucrative years for those who were invested in risk-on assets such as equities. Both 2023 and 2024 were years that showed more than 20% growth in U.S. stock indices. That was a lot of fun for those who were invested.

But, even with economic indicators pointing to another positive year for investors, more modest growth of 7% to 9% would be a more realistic target for this year. With an increase in anticipated market volatility, it would be historically highly unlikely to be another 20% growth year, so investors should prepare an honest look at their portfolio and their expectations.

Evaluating Sectors & Political Impact

Investors should consider how policy changes could impact financial markets. The current administration is expected to focus on economic growth, deregulation and potential tax reforms, which could benefit certain sectors over others.

Specific areas that might be worth overweighting include stocks over bonds, and specifically U.S. companies over international. Broadly, U.S. large companies will likely perform better than small and mid-sized companies. However, industry consolidation and a persistently strong merger and acquisition market, there’s certainly a case to be made that small and medium-sized companies could benefit.

Look for a couple of industry sectors to lead the pack, with technology and financial services and healthcare companies providing a great case for strength. Energy stocks are a significant question mark right now, but worth keeping an eye on for opportunities.

The accelerating artificial intelligence (AI) boom brings up memories of where we were 30 years ago with the birth of the internet. This is game changing technology, and there is a role for AI in nearly every business model, whether it’s adding efficiency, improving accuracy or building speed.

Chip makers are benefiting greatly from the rise of AI and are garnering a lot of attention from major investors. But there is room for retail investors, and this is a tech subsector worth watching.

There is a certain fear of tech market volatility among investors. Interestingly, you see large institutional investors expressing more concern than individual retail investors, taking some profits from the gains of the prior two years strength.

Note: 2022 was a painful year for tech investors and the institutional investors have longer memories than individuals. The most significant concern right now when it comes to investing in technology stocks is that some individual investors have concentrated positions in these holdings. They have performed very well, but as a result their investments are no longer aligned with their risk profiles. There is more downside market risk embedded in their portfolios today than there was two years ago because of swelling in that sector.

Trimming some of the growth on these investments that have done so well could be a smart move as 2025 progresses. Tech is the most visible example of a sector that runs hot, and because of its rapid growth investors end up with a larger share of the sector than might fit their risk profile. Consider trimming some gains in tech stocks and rebalancing into sectors with strong fundamentals but lower volatility.

Ideal Portfolio Composition for 2025

The ideal investment portfolio depends on how quickly you need to access your money. But no matter how soon you need the money, tax planning is a key factor in balancing a portfolio. For those in higher tax brackets, addressing the risk of tax drag is important. Finding tax-free income sources, such as individual municipal bonds, can protect against market risk and provide tax advantages.

Certain fixed income instruments, such as United States Treasury bonds, offer tax advantages by being exempt from state income tax. Municipal bonds can provide federal and state tax-exempt interest, also making them attractive for high-tax-bracket investors.

On the fixed income side, it’s important to note that buying individual bonds – as opposed to bond mutual funds – can give an investor more tax control and can help them keep more of their money in their pockets. This helps the investor exercise control over not just overall return, but after-tax return. While the benefits of owning individual instruments are more pronounced on the bond side, the principle is the same on the equity side, where owning individual stocks can enable the investor to harvest tax losses to offset capital gains, as opportunities arise.

Key Messages for Pre-Retirees

Many investors as they approach retirement age take on less and less market risk because they think that when they retire, they need to be at a zero-risk profile. They have taken to heart the conventional wisdom that has been put forth by investment advisors for decades – don’t risk your hard-earned gains right at the time when you’ll need the money.

But for many investors these days, this could be a mistake. The remainder of their post-retirement lives could play out over several decades. People are living longer now and, in many cases, retiring earlier. Getting too conservative too early can result in outliving your investment resources.

Many people live well into their 80s and 90s these days, so they may have 25 to 30 years of retirement spending.  Making even a healthy portfolio last that long can be a challenge, so you want some growth. Moreover, children born today have a more than 50% chance of living beyond 100. Our children will likely have very different ideas than we do about risk management when they are saving for retirement with life expectancy into their triple-digits.

Many pre-retirees invest their 401(k) savings in target date retirement funds. These are funds that are managed to gradually minimize risk until the year you think you may retire. It’s a great concept, but so many investors select these funds, not taking a critical look at the investments that make up the target retirement date fund portfolio. Some of these target date funds are overly concentrated in international assets, and being aware of international exposure in your fund is extremely important, as it drives up risk. If you are invested in a target date fund, look at the investments in the fund and consider doing some custom allocations if you find a concentration in international assets.

Sector Rotation & Long-Term Performance

Sector rotation is common, but it’s important to remember that top-performing asset classes one year can fall to an underperforming profile the next. It’s essential not to base investment decisions solely on recent performance but to participate in all areas to benefit from growth across asset classes.

Evaluating longer-term patterns and history provides a clearer picture of an asset’s trajectory.

Managing Cash & Fixed Income Risks

Every once in a while, an investor thinks that leaving the equity markets altogether and putting their money into cash and bonds is a great way to eliminate risk. Not so. They’ve eliminated one type of risk, but when they’re too heavily concentrated in cash or fixed income instruments, they run into interest rate risk.

Investors need to be mindful that the bond portfolio has inherent risk inside of it, and a good way to offset interest rate risk is with growth positions.

Questions?

Investors should not expect returns in 2025 to mirror the exceptional performance seen in 2023 and 2024. By being educated and evaluating risk and holdings carefully, you can ensure your portfolio aligns with your overall risk profile in a manner that achieves your financial goals.

If you would like to discuss rebalancing your portfolio, contact an Adams Brown Wealth Consultants advisor.