Personal investments have two main factors you need to consider. Risk and reward. As a general rule, these two have a positive correlation with each other. Meaning the higher the reward, the higher the risk. However, this may not always be true the other way around. High risk may not always translate into high reward. Sometimes it’s just a lot of risk without as much of a potential payoff as you might like. Risk is not bad, but you want to mitigate them and get the most reward possible for the least risk. It’s not quite as straightforward as deciding to buy internet plans but we will try to explain.
7 Ways to Mitigate Investment Risks
There are a number of steps that you can take to minimize the risk on your personal investments. Risk isn’t always a bad thing. But the important thing is to recognize the risk level that is tolerable to you and proceed from there. This blog explores the following seven ways to help reduce the risks you take on your investments:
- Recognizing Acceptable Risk
- Diversifying Your Portfolio
- Invest in Non-Correlating Assets
- Have a Put Option Strategy
- Using Stop Losses
- Principal-Protected Investments
Let’s take a closer look at these steps below.
Recognizing Acceptable Risk
You can’t invest money without taking on some risk. That is a fact. But understanding the risk and types of risk associated with a particular investment is essential. Especially if you want to take steps to reduce those risks. There are two key indicators you should look at when deciding what is an acceptable risk level for you. The first is your net worth, which is your assets minus your liabilities. Decide if you can invest money which, if lost, would not affect your lifestyle. Higher net worth means a higher risk tolerance. The money that you can risk investing is your risk capital. The higher your risk capital, the higher the risk you can tolerate.
Diversifying Your Portfolio
Modern portfolio theory strongly stresses on diversifying your investments. A diverse portfolio has a better chance than a concentrated portfolio in the event of a market downturn. Experienced investors know it is better to create broader and deeper portfolios. This means owning more assets in different classes, so there is a lesser unsystematic risk, which comes with concentrated portfolios.
Invest in Non-Correlating Assets
Systematic risk, as opposed to unsystematic risk, comes with investing in a market generally, instead of a single entity. It is always present, but you can take steps to mitigate it by investing in non-correlating assets. These can include real estate, currencies, commodities, bonds, or even stocks. This results in lower volatility in your portfolio. Different assets will react differently to market changes, offering more balanced returns.
Have a Put Option Strategy
Put options are an interesting way to lock in your profits without having to sell. Many investors prefer to take their profits off the table when stocks do well, but may also miss out when the stocks climb even higher. A put option is a bet that the underlying stock price will go down. This put option gives you the choice of selling at a certain price at a specific point in the future. You aren’t making money of the put options, instead, you’re protecting your unrealized profits.
Using Stop Losses
Share prices can plummet suddenly, as many investors know all too well. One way to protect your investment from this is to stop losses. There are a number of stop losses that you can use. Hard stops sell a stock at a fixed price. This means if the share price drops to the stop, the share is automatically sold. Then there are trailing stops. This moves according to the current share price. You can set it in either percentage or in dollars. You need to plan out your stops carefully. While they protect you from sudden market changes, they can also make temporary losses permanent.
Dividend-paying stocks are a great way for you to protect your investment portfolio. In most cases, a dividend accounts for a stock’s significant value. In some cases, dividends may even represent the entire value of the stock. If you want above average returns, invest in stable, dividend-paying companies. Dividends offer cushions to risk-averse investors in declining markets. Dividends also help you hedge against inflation, especially if you invest in blue-chips with pricing power.
Investing in principal-protected notes that have equity participation is a great way for investors to protect their principal. If you hold the investment till it matures, your principal is usually protected, much like investing in a bond. But unlike bonds, they also include equity participation. You forfeit profits in declining markets in return for protecting your principal. Banks usually guarantee principals, but it would be a good idea to check the guarantor bank’s strength before investing. After all, wouldn’t you check Spectrum internet prices without bundle ability before buying? The same principle applies to investments.
Author bio: Alex Brian is a writer by choice and digital marketing consultant with experience of working with various startups in the past 8 years. With a mix of creativity and analytical abilities, He has helped many online businesses. He can proudly claim a big part in their success story.
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