9 ways to manage investment risk
Written and accurate as at: Sep 07, 2020 Current Stats & Facts
The current low-interest rate climate, volatile share market and uncertain economic future have caused fear and confusion amongst investors. Yet, the need to maximise returns and minimise risk has not abated.
Most things in life involve taking some risk – even getting out of bed in the morning! Understandably, many people are fearful of investing because they focus on the risk of losing their hard-earned money. Whilst others, look for great returns and ignore the risks. As with most things in life, there is a balance.
In many investment structures, a relationship between risk exists amongst the majority of investment markets. In theory, the greater the risk, the greater the potential for higher returns (and vice versa). However, this is not always the case.
There are methods investors can use to manage risk without defaulting to low-return investments. Here is a handy checklist that contains some key tips on maintaining risk and reward.
1. Learn more and be aware
Many investment disappointments come from a lack of knowledge. Ask questions until you understand the investment. If you do not understand it, do not invest in it. Do not trust easily.
2. The value of money
Your investment return needs to take account of tax and also stay ahead of inflation. Many low-risk investments, such as bank savings accounts often do not achieve that goal. To make any gains, you must take calculated risks. Conversely, investing in financial markets can be expensive, so it is important to consider expenses, turnover and tax.
3. Rely on experience
Software and mathematical models can increase understanding, but in the end, it is people who make the difference. Smart investors seek the help of experts.
4. Never assume
It is easy to make assumptions and accept the information that is being given to you. You must test these assumptions through questioning.
5. Understand the risks
It can be tempting to pretend that risk is small if something sounds really good. You must accept that risk always exists and structure your investment along the dimensions of expected returns.
6. Mix up your investments
Diversifying means you take on more ‘uncorrelated’ risk. The larger number of small and different investment risks you take can provide a higher probability of more consistent returns. Create an investment plan to fit your needs and risk tolerance.
7. Stay focused
Be consistent. A rigorous and systematic approach will beat a continually changing strategy every time. It is crucial to stay disciplined through market dips and swings.
8. Use common sense
Investing requires you to make judgements rather than following a script. It is better to be approximately right than to be precisely wrong.
9. It’s not just about returns
It is all about risk and returns. Accepting and managing the risk may help you realise the return you desire.
Just like achieving other goals in life, you need to decide how much risk you are prepared to take in chasing higher rewards. Diversification does not eliminate the risk of market loss, and there are no guarantees investment strategies will be successful.