Investment risks, or the chance that your investments could potentially lose value or fail to achieve an important financial goal, is a reality for every investor. Charting the road to meeting your financial goals means managing investment risk in your portfolio.
For most investors, this is as basic as having an appropriate asset allocation and diversifying investments within each asset class (stocks, bonds and money markets). For experienced investors and mutual fund managers, trying to manage investment risk is more complex, sometimes relying on financial instruments to try and minimize risk.
Who needs to manage investment risk? Every investor
The idea of implementing effective risk management strategies can seem intimidating at first, particularly if you're a novice investor. The principles, however, are simple enough for anyone to understand. Don't assume that you don't need to worry about investment risk because you own shares of a mutual fund. Mutual funds carry the same types of risks as any other investment, and they can lose value over time.
Managing investment risk begins with a focus on your most important investment priorities, such as identifying financial goals, understanding your own tolerance for investment risk and selecting a mix of investments that's appropriate for your unique needs.
Types of investment risk
The types of risk you face as an investor should directly influence your risk management initiatives. Depending on the types of investments you choose, you'll face one or more of the following risks:
Best practices for investment risk management
As an individual investor, your two most important risk management priorities should be to determine an appropriate asset allocation for your portfolio and to diversify your assets to try and minimize the risk of loss.
Your asset allocation is your big-picture investment strategy; a general overview of the types of investments you own, often expressed in percentage terms. For example, if you invest exclusively in stocks, your asset allocation is 100% stocks. If you own an equal mix of stocks and bonds, your asset allocation is 50% stocks and 50% bonds.
Your asset allocation should complement your personal financial goals, including your time frame, risk tolerance and overall financial needs. As a rule of thumb, the higher your investment risk tolerance and the longer your investment time frame, the more stocks you may want to include in your portfolio. Stocks will bounce around in value over the short term, but over time they have historically provided the highest rate of return to investors, though past performance is no guarantee of future results.
Diversification is an essential portfolio risk management strategy that reflects the age-old wisdom, "Don't put all your eggs in one basket." By investing in a well-diversified mix of potentially complementary securities, you could minimize your overall portfolio risk. Gains from some investments might offset losses incurred by other investments.
Be careful not to go too overboard with diversification. Some investors spread out so thin that they essentially hold the market, a tactic that is much more easily achieved with investments in a handful of index funds.
When you're in debt and living paycheck to paycheck, the idea of investing seems completely out of reach. Just keeping the bills paid on time and not sinking further into debt can be very difficult.
With all of the financial changes that go along with raising a young family, you may feel like you'll never get to retirement. Though it may be far off, evaluating your retirement saving plan and making some important adjustments can help ensure that you have a comfortable future. Here are some tips to help you assess your finances and look ahead to retirement.
If your New Year's resolution was to get your finances in order these tips will give you the boost you need to keep your goal on track. Keeping good financial records will help you manage your money and make it grow. Just think of the small amount of discipline you apply to smart record keeping as training for the more demanding (and rewarding) money management tasks like saving and investing.