Investment is at the core of financial security and is often promoted as a tool that provides long-term support but at the core, all future investments yield results based on factors that we might not foresee. Managing risk is key to a successful investment portfolio.
Risk is perhaps the most predictable aspect of investment. Traditional savings and keeping money in a bank prove to be ineffective in an inflation-led environment and this diminished value of money has brought investment to the forefront of financial literacy. For example, a 30-year-old who invests half his savings with the bank minimised the risk attached to market fluctuations or real estate but he has also not realised the returns that his portfolio could have received.
Here are some tips to help you minimize risk and maximize returns: diversify your investments, have a long-term investment strategy, regularly review and rebalance your portfolio, and invest only what you can afford to lose.
Understand what is risk.
Risk can be effectively managed only after each portfolio manager has a firm grasp of the concept of risk and how it can affect an investment portfolio. It is imperative to start by identifying the portfolio risks and analysing the ratio of portfolio risks across the entire set.
Before you invest, it's essential to understand how much risk you're comfortable taking on. It is important to understand that each person/institution has a specific Risk capacity, simply put it is how much risk you can afford to take. This is dictated by how much you can invest and is based on income needs, time frame and money available.
Another important factor is Risk tolerance, it is the acceptable amount you might have to gain or lose over time. This is perhaps the biggest differentiator between a rookie and an expert, higher tolerance does not make you better at picking investment vehicles but increases the probability of a high return.
Risk composure, this factor deals with the emotional reaction and is based on the personality and outlook of the investor.
How do you react to the events of the market and does it impact you to make smarter or impatient decisions? Based on one’s approach to risk a focused investor develops a portfolio risk response that ensures that they can monitor and control portfolio risks to match your investments to your goals.
The various kinds of risks involved
To effectively manage risk, consider all the available and relevant information before investing or making a change in your portfolio. However, it is crucial to accept that no one can predict the future and hence, risk can be minimized and never eliminated. Investors need to understand and consider the different types of risks when making investment decisions. Here are a few of the most common kinds of risk:
Market risk: The risk that the overall stock market or a specific sector of the market will decline, causing the value of an investment to decrease. For example, a decline in the stock market is has and adverse effect on the value of the stock mutual funds in your portfolio.
Credit risk: The risk that a borrower will default on a loan or bond, causing the value of the investment to decrease. Bonds and bond funds are given credit ratings by such agencies as Moody's and Standard & Poor's. In general, the higher the rating, the lower the credit risk. People seek higher yields to compensate for their higher credit risk.
Interest rate risk: Often associated with fixed-income investments, it’s the risk that changes in interest rates will impact the value of an investment, particularly fixed-income investments such as bonds.
Inflation risk: The risk that the purchasing power of an investment's returns will be eroded by inflation.
Liquidity risk: All investment is made with the idea of an eventual sale of the assets but not all investment tools have a quick liquidation. You might want to sell quickly to prevent or minimize a loss but that may or may not happen in most cases.
Political and economic risk: The risk that political or economic events will negatively impact an investment.
Currency risk: The risk that changes in exchange rates will negatively impact an investment.
Operational risk: The risk that an organization's internal processes, systems, human errors, or external events will disrupt its operations.
Manage the risks with diverse investments
Risk management needs to recognize the combined contribution that people and culture have to achieve your objectives. process of managing risk needs to be flexible. The challenging environment we operate in means you need to consider managing risk in your investment portfolio as an essential part of achieving your financial goals. Here are a few tips to help you manage risk in your portfolio:
Diversify your investments: Diversification is one of the most effective ways to manage risk in your portfolio. By spreading your investments across different asset classes, sectors, and geographies, you can reduce the impact of any one investment on your overall portfolio.
This will help you make more informed investment decisions and ensure that your portfolio aligns with your goals and risk tolerance.
Regularly review your portfolio: Regularly reviewing your portfolio will help you stay on top of any changes in the market and make adjustments as needed. This can help you identify any potential risks and take action to mitigate them.
Have an exit strategy: Having an exit strategy in place can help you manage risk by providing a plan for what to do in case of market volatility or other adverse events.
Rebalance your portfolio: As the value of the changes of your investment, the risk profile of your portfolio may change as well. Rebalancing your portfolio by selling some of the investments that have grown in value and buying more of the ones that have lost value can help you maintain your desired level of risk.
Invest in low-cost index funds: Index funds are a simple and low-cost way to diversify your portfolio and reduce risk. Because index funds track a market index, they don't require the same level of research and analysis as individual stocks.
Don't try to time the market: Attempting to time the market by trying to predict when it will go up or down is a risky strategy. It is better to focus on creating a diversified portfolio across many sectors, tools and trust the investment plan.
Be disciplined: While you may consider alternative investments, the most important aspect is to stay disciplined with your investing. First time investors are often tempted to try to predict the market during periods of volatility and make quick decisions based on a hunch instead of research – creating the perfect crash.
Be prepared for market corrections: Investing instruments are tools to help build a parallel income stream for the future, but they don’t always work for shorter-term goals. It is important to calculate your goals, time frame, risk tolerance and seek the guidance of a financial professional to help you select investment vehicles that are suitable for you. By following these tips, you can effectively manage risk in your investment portfolio and achieve your financial goals.
Remember, no investment is risk-free, but by working with professionals and learning more about the investment opportunities you can be more confident in your investment decisions. Join us at the AIM Global 2023 to make informed choices, identify priorities and select the most appropriate action.
