Where there is reward, there is almost always risk. When it comes to investing, the term risk simply means that there is a potential that your initial efforts won’t meet the expected outcome – meaning you lose some or all your original investment.
Risk isn’t always a bad thing, as it can have major financial benefits in the long run. Using a risk profile, you can determine what kind of risk you should be taking with your investments based on your age, lifestyle, and even your personality. Read below to learn more about risk and how to manage it.
The Basics of Risk
Essentially, the more risk a person is willing to take, the greater potential the investment has for return. This is called risk tolerance. When deciding what kind of portfolio to invest in, investors have a few different risk profiles to consider, including:
- Conservative: Investors with a conservative tolerance are risk adverse and choose to make investments that have a steady return, such as certificates of deposit (CDs) and money markets.
- Moderate: Moderate investors typically balance both aggressive and conservative investments, typically through mutual funds or bonds.
- Aggressive: Investors with an aggressive tolerance are market-savvy individuals who take larger risks for the potential of big rewards.
When considering risk, there are also different types of risk to consider, such as:
- Business Risk: If you have money in bonds or the stock market, then business risk can affect your investments. these types of investments to make a return, the company must be in business. However, risk exists because not all companies succeed, and if the company closes or goes bankrupt, then the stakeholders are the last considered for remaining profits and proceeds from existing assets.
- Interest Rate Risk: Changes in interest rates affect the value of bonds. If held to maturity, an investor may be able to profit from the face value of the bond and its interest. However, if an investor sells a bond before it reaches maturity, the bond may be worth less, depending on interest rates.
- Liquidity Risk: How easily an investment can be purchased or sold on the market will affect the liquidity risk and can directly affect profit and loss.
Risk can be daunting, but with the right strategy and tools, you can learn how to manage it effectively.
When it comes to managing risk, there are multiple strategies you can utilize, and no tactic is one-size-fits-all. When adjusting your investment portfolio, consider the below to manage portfolio risk.
Having a diversified portfolio means that your assets are not correlated, and if one goes down, others are likely going up. This balance helps investors limit risks associated with investing, but only if assets are truly uncorrelated. At times, it may be harder to diversify depending on the market. For example, some stocks and bonds may move in the same direction, making them correlated and not diversified. Talk to a financial advisor if you’re unsure about your investment correlations.
Stop Loss Orders
Essentially, you can place an order with your broker that will allow you to sell all or some of your investment automatically if the value of it falls below a certain price. The strategy comes with determining a price point that is high enough to limit your capital loss if you sell your stocks, but it can be difficult to find the right number.
As an investor, you can also manage risk by reducing your portfolio volatility. This means that you’re calculating an investment’s risk-reward combination. A high-risk portfolio means high volatility because you can lose the value of your overall investment, but a lower-risk portfolio reduces volatility, ensuring your portfolio performs well and earns money. Read Investopedia’s blog about ways to measure volatility here.
There are various ways to manage your risk, but it’s best to meet with a financial advisor to better understand your portfolio, strategies to grow your assets, and reduce risk overall.
You should also utilize financial resources, like Bespoke, or other managed account solutions offered through your 401(k) retirement savings plans to help create an investment path and set goals. Simply open an account, establish goals, and let the algorithm manage your investments for you. If your goals change, update your account and Bespoke adjusts your portfolio to match.
Get more financial advice related to making, saving, and investing money on the Slavic401k blog.