Risk is a common consideration in all aspects of investment.
The first people to buy Bitcoin had to take the risk that the cryptocurrency market wouldn’t grow the way they thought. Modern traders in the stocks and forex markets need to take the risk that their purchases will grow in value by the time they’re ready to sell.
While all kinds of investment come with risk, there are strategies you can consider to reduce how much risk you take on. These plans aim to reduce the losses you might experience if your purchase doesn’t deliver the kind of return you expected.
Reducing Your Investment Risk
Risk management strategies are often concepts applied to an entire portfolio, as well as individual trade decisions. Different people approach risks in different ways. When you start investing, you can talk to a financial advisor or coach about how you should spend your money. The advice you get will be tailored to your “risk tolerance.”
Risk tolerance essentially identifies how much risk you can reasonably take on. For instance, if you have a lot of spare capital, you can afford to take higher risks without massive losses. If you don’t have a lot of money, and a bad move would wipe out your savings, you might need to play it safe.
While different investing methods come with their own risk management considerations, a few strategies can work for all kinds of assets. For instance:
1. Always Diversify
Diversification is both a strategy for financial portfolio growth and risk management. When you diversify your investments, you purchase a range of different assets from different environments. Some people diversify by buying different kinds of securities, like stocks and Forex. This ensures that if one security loses value, you can still earn from other investments.
It’s also possible to diversify in the purchases you make within each security category. For instance, you can buy different kinds of cryptocurrency, or purchase stocks from businesses in different industries to reduce your risk. The idea is to avoid placing all of your eggs in one basket and make sure you’re always hedging your bets.
2. Don’t Invest All Your Cash at Once
Investing all of your money at once might seem like a good way to speed up portfolio growth, but it puts you at a higher level of risk. Before you even start investing, it’s often worth considering whether you can improve your financial health in other areas. For instance, it may be helpful to build an emergency fund in case anything goes wrong in your life and pay off your debt before you get into purchasing stocks and securities.
You can speak to a financial professional about your risk tolerance, so you know how much you can reasonably afford to spend. Once you know how much capital you have, you can then start considering how you want to spread your cash between different opportunities.
3. Reduce Portfolio Volatility
Volatility adds significant risk to any portfolio. One of the best ways to avoid risk is to keep some amount of your cash allocated to cash equivalents and cash in general. This can stop you from having to cash in on your assets when you’re low on funds, meaning you could miss out on important periods of growth. The amount of cash you keep in your accounts will depend heavily on you.
Speak to a financial advisor about how you can balance your risk by keeping the right amount of cash available at all times. You may also need to think about how you’re going to balance your investments between short-term and long-term earnings. Long-term investments are often far less risky than their counterparts, though they may not grow as quickly.
4. Use a Margin of Safety
Perhaps the best-known mantra among investors is to buy low and sell high. However, it’s often difficult to determine what’s high and low when you’re getting started. Many value-minded investors implement something called a “margin of safety” to protect their cash. For instance, a margin of safety of 20% would mean you’re drawn to stocks with the intrinsic value of around $100 per share but a price of $80 or less.
The higher your margin of safety, the higher your potential will be for steady returns. Determining the intrinsic value of each asset you choose to invest in is often the toughest part of using a margin of safety. To begin, you can consider looking at the “price-to-earnings” ratio listed by the stock.
5. Create a Maximum Loss Plan
Sometimes, the best way to ensure you can handle anything in the investing world is to prepare for when the worst might happen. A maximum loss plan is a method used by professionals to manage asset allocation and protect against bad decisions. A bear market can have a huge impact on your portfolio, but if you have a maximum loss plan, you can invest more cautiously and take risks suitable for your long-term goals.
A maximum loss plan requires you to focus on the valuation of each asset and think about the bigger picture rather than making decisions based on your anxiety right now. You can get guidance from a financial coach to decide what your maximum loss plan should look like.
Whether you’re an aspiring investor or someone who’s been in the game for quite some time, you’ll always face risks when putting your money in an investment asset. The good news is that you can reduce much of that risk by following the tips above. No, you can’t completely eliminate the risk, but that doesn’t mean you can’t increase your odds of getting a positive return on your investment.
And remember, your portfolio is most risky when you’re just following word-of-mouth suggestions. Markets are unpredictable, but the greater risk is doing what everyone else is doing without studying the market. In this case, consulting a professional financial management coach should help reduce your risk tolerance and provide you with effective options to invest your money for the best returns.