investment risk management strategy. Every day, there is a risk. Some people take precautionary measures to protect themselves and manage the risk. Others leave it to chance.
The same is true for accumulating wealth for the future. Some investors are solely concerned with returns and how quickly their money can grow. Others use various risk management strategies to protect themselves against the inevitability of a correction or bear market.
Investment risk management strategy
That prudence does not imply that they are paralyzed by fear, stuffing money under the mattress, or only investing in the safest investments they can find. The goal of investment risk management is to ensure that losses do not exceed an investor’s acceptable limits.
It is about determining the level of risk a person is willing to take and constructing an investment portfolio with appropriate investments that will also help that individual achieve his or her goals. The risk tolerance of an investor is typically determined by three major factors:
Risk tolerance: How much can the investor afford to lose without jeopardizing his or her actual financial security? Risk tolerance varies according to age, personal financial goals, and an investor’s timetable for achieving those goals.
Need: How much will these investments have to earn in order for the investor to get to where they want to go? (An investor who is heavily reliant on investments may have to walk a fine line between taking too much risk and not taking enough risk.)
Emotions: How will the investor react to bad news (with fear and panic? or clarity and control? ), and how will those emotions influence investment decisions? Unfortunately, this can be difficult to predict until it occurs.
What is the significance of risk management? Those who can keep their capital safe during difficult times will have a larger foundation to build on when the good times return.
Keeping this in mind, here are some strategies that investors may employ to manage risk in their portfolios.
Strategies to Help Manage Investment Risk
1. Reevaluating Portfolio Diversification and Asset Allocation
You’ve most likely heard the phrase “don’t put all your eggs in one basket.” Portfolio diversification, or allocating money across multiple asset classes and sectors, may aid in avoiding disaster during a downturn. If one stock tank fails, others in different classes may be spared.
Investors should consider owning two or more mutual funds representing different styles, such as large-cap, mid-cap, small-cap, and international stocks, as well as a timeline-appropriate percentage in bonds. Those nearing retirement may want to consider adding an income-producing fund to their portfolio.
However, investors should be wary of overlap. Investors frequently believe they are diversified because they own a few different mutual funds, but upon closer inspection, they discover that those funds are all invested in the same or similar stocks.
If those companies or sectors fail, investors could lose a significant amount of money. Investors could avoid overlap by simply reading the prospectus of a fund online.
To further diversify, investors also may want to think beyond stocks and bonds.
To diversify further, investors may want to consider options other than stocks and bonds. Among the options are exchange-traded funds, cryptocurrency accounts, commodities, and real estate investment trusts (REITs).
Investors could also diversify their investment strategies. The days of turning to a stockbroker or a financial advisor to grow your money are long gone.
An investor may have a 401(k) through his or her employer, but he or she may also open a traditional IRA or Roth IRA online through a financial firm.
Picking the “right” stock and selling it at the “right” time is everything for those looking for quick returns. It is not the same as using a dollar-cost averaging strategy. It all comes down to patience, discipline, and thinking long term. It can also assist investors in keeping emotions at bay during the process.
Dollar-cost averaging requires investors to contribute the same amount to an investment account at regular intervals (usually once or twice a month). When the market falls, the money buys more stock. When the market is rising, it purchases fewer items.
However, because markets generally rise over time, investors who can keep their hands off the stash may be able to build a pretty nice pot of money over time—especially when compared to what they might get from a savings or money market account.
Some investors hand over their money every month with little regard for where their 401(k) plan administrator or bank with their IRA might put it. However, carefully selecting the companies represented in a portfolio—particularly those with long-term growth potential—could help strengthen this strategy.
Requiring a Margin of Safety
“Buy low, sell high!” is a popular financial industry adage, but putting the concept into practice can be difficult. Who gets to say what’s high and what’s low?
Value investors create their own margin of safety by deciding that they will only buy a stock if its current market price is significantly lower than what they believe its intrinsic value is.
(For example, an investor with a 20% margin of safety would be drawn to a stock with an estimated intrinsic value of $100 per share but a share price of $80 or less.)
The greater the margin of safety, the greater the potential for solid returns and the lower the risk of a downturn.
Because risk is subjective, each investor’s margin of safety may be different—it could be 20%, 30%, or even 40%. It is up to the individual to determine what they are comfortable with.
It may be necessary to conduct some research in order to determine intrinsic value. The price-to-earnings ratio (P/E) of a stock is a good place to start. Investors can calculate this number by dividing a company’s share price by its net income and comparing the result to the P/E ratios of other companies in the same industry.
The stock is “cheaper” if the number is lower in comparison to the competition. The greater the number, the more “expensive” the item.