How to reduce your risk when investing
If you’re investing in anything other than the risk-free return of bank deposits and bonds, you’re going to experience some level of volatility. Volatility is the degree by which an asset’s value changes in a given period. The greater the movement, the higher the volatility. In simple terms, volatility equals risk.
As financial planners, we’re often asked if we can recommend a low-risk investment that will make high returns. Unfortunately, such an investment doesn’t exist. However it’s possible to mitigate risk so that the chance of suffering a loss is reduced. Is there a secret that we’re not telling anyone? Not at all. Most of the methods to reduce your risk are quite logical. Below we list our top four.
Method 1 – Understand the time frame
Time is probably the single greatest factor that should come into account when reviewing the risk of an investment. In the short term, an asset’s value can go up and down. But over time, a quality asset will usually go up in value. Consider your personal needs when looking at time frames. If you make investment in the stock market but need your money back in two years, it’s possible that you’ll lose money. However if you can put the money aside for 10 years, you’ve got a much better chance of earning a profit.
Take out: Select investments with an understanding of both the acceptable timeframe for the investment and your personal needs.
Method 2 – Research the investment
While it may seem logical to say that you should know what you’re investing into, many people take the plunge into an investment without properly considering all of its facets. This could be due to being overly optimistic, fearful, or pressured into a decision. If you understand the investment, you’re going to be able to assess if it’s the right one for your personal situation. Furthermore, you’ll be less likely to panic and sell it at the wrong time.
Take out: Research your investments, ask lots of questions and don’t go ahead with anything unless it makes sense to you.
Method 3 – Diversify your investments
Make sure that you don’t put all your eggs in one basket and spread your money over different asset classes. Different asset types have varying characteristics and behave in different ways. Diversity gives you options if you need to sell to access funds, as usually one of your investments will be doing better than others.
Take out: Invest in a mix of asset classes to minimise losses should you need to sell.
Method 4 – Have a backup plan
Do keep some money aside when investing. You don’t want to be in a position where you have to sell an investment when it’s value is down because you need the cash. How much money you need to retain is a personal decision only you can make. Consider your risk profile, living costs and lifestyle. Having money aside will enable you to ride the ups and downs a lot easier and will allow you to retain your investments even if you suffer a potentially catastrophic event such as major illness, accident or losing your job.
Take out: Keep a sum of money aside for emergencies.
Investments are never for the short term; they take time and patience to work properly. Investing should be part of your overall financial strategy so that you know what you’re doing, why you’re doing it and what you hope to get out of it.