They say the only guaranteed things in life are death and taxes. Everything else is up to chance. This is especially true when it comes to investing.
Investment always comes with a modicum of risk that you will lose out. Sometimes this loss will be small; sometimes, it might be big. Either way, this does not necessarily mean you should abandon the investment. Though many factors are out of your hands, you can still plan your investments around them.
As an investing coach, I remind my clients often that research and proper planning can go a long way towards managing risk and reward. Here are some important things to consider as you decide on the best balance for your investing strategy.
Risk vs. Reward
When it comes to investing, any stock or company that looks promising comes with the risk that it might not change fortunes. On the flip side, riskier investments tend to be more rewarding than 0.1-1% APY vehicles.
A good example of this is Netflix, which saw an enormous return of almost 41% back in 2020 during the early days of the pandemic. With the whole world locked down, people turned to the streaming service to help wile away the quiet hours, giving investors a mighty boost. However, the media giant saw a sharp drop from $691.69 per share in November 2021 to $336.54 as of Mid-March 2022, as schools reopened and employees returned to the office.
Going into the pandemic, many investors could easily anticipate a sharp rise in many industries, such as healthcare and delivery products. This same rise was also seen with the inevitable drop-off once the pandemic restrictions were reduced, as these products and companies would have the same level of use as they had before the pandemic started. This meant that the risk of investing in them increased as the days wound on, but the reward for sticking with them from the beginning and leaving just in time was great.
Types of Investment Risk
The way we measure investment risks varies from person to person. You will have to assess your own plans to determine what your limits are, but they tend to fall within four main categories:
- Not reaching your goals – the most obvious risk is the idea that your investments won’t bring you the kind of return you are hoping for.
- Losing your principal – some people don’t aim for high return, but fear the idea of losing everything they invested upfront.
- Falling behind the rate of inflation – even if their investments are pulling in money, some options will not keep up with inflation, causing the return to be much smaller than it could be.
- Paying too much in fees – what good is extra income if it barely covers the fees required to make it? If the investments’ costs outweigh their profits, they could render the whole attempt useless.
You can decide for yourself what your own goals are, but knowing what you want to avoid will affect how you plan your investments.
How to Balance Risks and Rewards
If you feel unsure about the prospects or how well you might come out the other side, this is a good sign that you are not as welcoming to risk. It is always sensible to stick to low-risk, low-reward investment opportunities in these cases.
If, however, you want to add a little spice to your portfolio and there is potential to rake in some bigger returns alongside your steady investments, then you’ll find a few suggestions here.
● Risk through diversity
As with all things investment, you should keep your portfolio diverse. Don’t invest all your money into two or three options, especially not all risky or all safe. If you want to guarantee some income for the future, then always make sure you have a hand of low-risk, low-reward investments in your portfolio. Whether this is a retirement fund, a savings account, or a government-backed treasury fund, you can always be sure that you will have something waiting for you at the end. You can then make some riskier investments of varying degrees without the risk of losing everything.
● Assess the risks to determine your stake
Since no two investments will have the same factors going for them, you will need to consider the following:
- What do you want to gain from the investment? If you want the investment to provide a steady income, you don’t want it to disappear in a flash.
- How long are you going to invest? If you are looking to invest for longer periods, you will be better off with good interest rates, but if you’re looking to sell some stocks off sooner, you might be better off investing in fast-growing companies.
- How much can you afford to lose if it goes wrong? If you have little to no savings already, then high-risk investments are not a good idea. You don’t want to lose everything you have. But if you already have a good amount in reserve, perhaps you can put a little of that into something more volatile.
- How risky is the rest of your portfolio? If you have a large portfolio of risk-free investments, then adding one or two riskier ones, with the above in mind, wouldn’t be a bad idea. However, if your portfolio is mostly risky investments, play it safe and add in some safe bets.
The stock market is a highly unpredictable beast. The housing market has its ups and downs. Savings accounts will always give you something, but rarely very much. There’s so much to the investment world that affects what we get out of it. And there are so many ways to use it. Why not diversify your investing strategy and add a few safer or riskier options to help provide you with a better future?