While some of us are risk takers, others will do anything to avoid risk. No matter what your individual preference may be, risk is necessary for any kind of growth whether that’s personal, professional, or financial.
Taking a new job involves risk. Choosing to start or end a relationship involves risk. Nearly every decision you make with your money involves risk.
When most people talk about investment risk, you’ll likely hear the word uncertainty. Risk comes down to managing uncertainty. You can’t be sure things will work out exactly as you plan. In fact, your investments may not deliver what you want, when you want, for any number of reasons. However, this doesn’t mean you can’t actively look to minimize your risk when investing.
Today, we are going to review five actionable strategies to help you do exactly that.
No Crystal Ball? No Problem
While you might not be able to do much about the new job or the relationship, when you invest, you can certainly take steps to minimize risk and protect your capital
With a little research and education, every investor can make more informed decisions, even before they begin investing. Once you’ve actually started to invest, you can continue to effectively manage risk by monitoring your portfolio with a modern tool like myRiskAlert.
Risk in trading can never truly be avoided, but it can be managed. Remember, everyone’s tolerance for risk is different. Your individual risk tolerance is likely to depend on your personality, age, and lifestyle.
What Is Risk in Trading?
To put it simply, risk in trading can be defined as the possibility of losing some or all of your investment.
Risk comes in many different forms in trading, like outside economic factors that impact stock value, the inherent value of the dollar itself rising and falling, or the overall time horizon of the investment being shorter or longer than intended due to economic hardship.
And while every investment vehicle carries a certain level of risk, some carry more than others.
For example, cryptocurrency and individual stocks can be highly volatile while offering the potential for equally high returns. In contrast, Exchange-Traded-Funds (ETFs) are considered lower risk because they are diversified into groups of investments. However, the return rate for this type of investment won’t be near what you could gain with individual stocks.
How risky is the market at any point in time? It depends. Risk is determined by analyzing historical performance and outcomes, but it’s only an estimate. There is no way to accurately predict how any individual stock will perform.
Why Is It Important to Effectively Manage Investment Risk?
The economy is in a constant state of flux and changes are inevitable. As a responsible investor, you will continuously need to decide what your risk tolerance is as you buy and sell stocks.
An effective risk management plan can have a profound impact on the value of your portfolio over time. Knowing how you will respond to various types of risk can alleviate a lot of stress and anxiety, as well as position you for long-term financial success.
Remember, effective risk management lies at the heart of “good” investing. Without a proper plan in place (and the tools to see it through), any investment action might as well be a wild gamble.
5 Strategies to Reduce Investment Risk
Don’t let risk intimidate you or keep you from using stock trading as an opportunity to grow your wealth. Here are five actionable best practices you can implement to help minimize risk as you invest.
1. Determine Your Risk Tolerance
No one invests with the intent to lose money, but you should have a plan for how much of a loss you can handle.
How much can you stand to lose? Perhaps 8%? Maybe 10%? Consider your overall financial state of being and how a potential loss would impact your other financial obligations. Once you have a good handle on this, you should be able to easily identify your risk tolerance.
If you’re an investor with an established emergency fund, you might be able to tolerate a higher degree of risk. And yet, if you have more financial obligations or dependents, or your timeline is more aggressive, you may need to choose investments with low risk. Either way, look to identify a risk tolerance and stick to it.
2. Keep (Some!) Investments Liquid
Putting all your money in long-term investments is a recipe for disaster.
If an unexpected financial emergency or an amazing investment opportunity arises and you need access to cash, well, you are out of luck. It’s a good idea to keep at least six months’ worth of expenses in a low risk investment vehicle like a high-yield savings account, money market, or a certificate of deposit.
You want to be able to have immediate access to this emergency cash without incurring a withdrawal penalty (as you would, for example, with a 401k). Once you’ve got your emergency funds set aside, you can allow your long-term investments to do their job knowing you have some cash on hand and peace of mind.
3. Mix It Up with Eggs in Multiple Baskets
The proper term for not keeping your “eggs in one basket” when it comes to investing is asset allocation and diversification. Don’t let your eyes glaze over just yet, because it’s simpler than it sounds.
Investing across different kinds of assets is a good way to insulate yourself from risk. If one investment isn’t performing well, then your others can hopefully offset the downturn.
Here are two principles to use to diversify your portfolio:
- Choose several different investment vehicles. Spread your investment across different kinds of assets including stocks, bonds, and other funds. Look at how they have performed historically to see if they are inversely related (meaning when one asset has historically been down, the other has been up).
- Choose different sectors. Investment sectors are grouped by business activity, like technology, financial services, or energy. Each will have a varying degree of risk and rates of return. Spread your investment across multiple sectors to better insulate from risk.
4. Invest With a Purpose and a Timeline
Time can be one of your best defenses in the stock market.
If you decide to sell or buy at the wrong time, it can cost you. Do your research to understand what you are investing in and assign a purpose for the investment as well as a proposed timeline. For example, let’s say you want to save for a downpayment on a home. Decide when you want to purchase the home. If you want to purchase it in five years vs. two years, that fact will likely impact your investment strategy.
Typically, the longer your window of time the greater your benefit will be from compounding interest. Economic experts often advise investors to stay the course even when the market seems to be entering a recession or a correction. Why? Because staying invested is the best way to weather unfavorable market conditions as it gives your investments the opportunity to recover.
5. Consider Blue-Chip Stocks
If you’re looking for a relatively stable investment with a track record of success, you should consider adding blue-chip stocks to your portfolio. These are large companies that have demonstrated stable earnings year-over-year, even through various economic downturns. Also, blue-chip companies tend to offer dividends and pricing power that other stocks can’t offer.
Regularly Monitor Your Investments With myRiskAlert
While the five best practices outlined above are all effective strategies for minimizing risk, one of the best strategies is to continuously monitor your investments. No one wants to find out after the market crashes that they suffered a significant loss. And yet, this strategy has traditionally required either 1) specialized knowledge (i.e., a portfolio manager) or 2) a lot of free time.
Luckily, in 2022, technology like myRiskAlert can help eliminate both of these roadblocks.
MyRiskAlert is an investment management tool that monitors your investments 24/7 so you don’t have to. You’ll get alerts to buy or sell based on your risk tolerance, giving you the opportunity to discover greater returns and better manage your portfolio. With myRiskAlert as part of your investment strategy, you can be sure you’ll get alerts to sell if your stocks are decreasing in value before it’s too late.
Yes, investing in the stock market involves risk. But don’t let the fear of risk keep you from enjoying all the potential benefits of investing. Use these strategies highlighted in this article to form a plan. Know how much risk you can tolerate, and let myRiskAlert monitor your investments for you.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, investment or accounting advice. You should consult your own tax, legal, investment and accounting advisors before engaging in any transaction.
