Managing Risk: While risk awareness can lead investors to make prudent decisions, it is also possible to be overly cautious. “Safe,” low-interest cash investments, like money market funds for example, are an excellent choice for preserving assets once one approaches or achieves their goal. But over the long-term, they generally cannot provide the capital appreciation needed to meet a significant investment goal. All investments involve risk, but there are strategies that one can follow to manage these risks and pursue your financial goals with more confidence.
Stay the Course: Some investors rush into the market when it is doing well and then unload their shares at the first hint of decline. While it is important to be knowledgeable about market movements, attempting to chase returns can be a risky business. If they have a significant investment goal, they must be willing to commit for the long term. The longer you remain with an investment, the greater its ability to withstand the market’s normal fluctuations.
Diversify: You can offset the risks unique to one investment by simultaneously spreading your dollars among others. This way, you can balance the greater price volatility of stocks, for example, with the more stable, income generating nature of bonds. This is called diversification. Diversification can also be accomplished by investing broadly within a particular asset, such as exposing the stock portion of your portfolio to different types of stock funds: an international stock fund, a large company stock fund and mid-size company stock fund.
Invest Regularly: Another effective method of managing risk is to invest regularly. That is, invest a consistent amount every month or quarter, regardless of what is happening in the markets. As prices fall, your regular investment will buy more shares, and when prices rise again, your existing shares will increase in value. Many working individuals have the opportunity to participate in this approach, also called dollar cost averaging, through their company’s retirement plan. Those who contribute with each payroll deduction are already familiar with the discipline and benefits derived from regular investing.
Put Risk In Perspective: Whether sampling a hot cup of coffee, crossing the street or beginning the first day of a new job, we all encounter many different types of risk. In the final analysis, only each of us can decide what we are willing to chance for meaningful rewards.
Certainly no one should build an investment portfolio that causes them to lose sleep, as they need to feel comfortable with both their investment objectives and the strategy they have chosen to achieve these goals. Regardless of your investment goals, you can benefit from an understanding of investment risk. By using proven risk management techniques and being committed to your chosen investment plan, you may find risk to be a valuable ally.
Image licensed through Shutterstock