In many ways, the principle of investment strategy can be summarized by the phrase “risk versus reward”. Usually, the greater the risk, the greater the potential reward, though this is not always the case. The bottom line, however, is that investing comes with risk, and how to manage this risk and keep to an acceptable level is an important part of the process.
You may have studied the markets that you want to invest in, and you may have access to the best share analysis, but if you are going to make a success of your investing, then you need to account for risk and ensure that your risk isn’t higher than you can handle.
An important part of dealing with risk is to determine the level of risk that you are prepared to undertake. Every investment that you make will entail some form of risk, and it is essential to understand what that risk is in order to minimize it. Two important aspects to consider here are risk capital and net worth. Net worth is simply your assets minus liabilities. Your risk capital is essentially the money that you can afford to lose. If your net worth is small and you have minimal risk capital, then low-risk investments will be more suitable.
Do your research
When it comes to investment, there is no such thing as too much research, and by applying yourself fully in this area, you will be in the best position to reduce your risk. Before you invest in a stock or fund, make sure that you know all the relevant statistical indicators, including earnings growth, debt load and stock history. You can also compare these figures to other similar investment products. Another important data indicator is the price to earnings ratio (P/E ratio), which measures the link between stock price and annual earnings. The higher the P/E ratio relative to other stocks in the same industry, the greater the risk.
Another good way to reduce your risk is to spread your investments over a range of product types and economic areas. This is known as diversification, and it is a useful way of spreading the risk of your overall investment package. For instance, you could choose to invest a third of your funds in stocks, a third in US Treasury bonds and another third in real estate. Obviously, this can potentially reduce your profits, but it is a good way to offset the risk of losses in one sector, and reduce the impact of one failing investment on your overall funds.
Monitor your investments
Finally, it is important to take a hands-on approach and monitor your investments, making sure that your funds are properly allocated, depending on your investment goals, which will be based on how long you are aiming to invest for, and how risk averse you are. At least once a year, it is a good idea to check your portfolio to keep your risk exposure as low as possible.
You can’t avoid risk when you are investing, but there is no need to take on unnecessary risks, and by following these simple tips, you can help to keep your risk level under control.