How to control investment risk

Controlling risk is key to your business strategy, in our last series we discussed investment risks. No investment is completely risk-free but some carry more risk than others, generally, the higher the expected return, the greater the risk.

Risk management requires prudent balancing of risk and return.

Assessing this balance, based on individual needs, should be the main concern when building a portfolio. Everyone talks about risk management but very few actually do it. In this series I explain why having some investment risk is important and how you can minimise it without sacrificing returns.

1. 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 you have a significant investment goal, you 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.

Focus on your investment goals usually when you buy growth investment assets you expect some short-term volatility, so it's important not to panic when markets drop. Consider whether the assets you hold are still appropriate to achieve your long-term goals.

Look at how market volatility has affected your investment in the past and consider whether there is any information available that suggests any short-term losses won't be regained.

2. THE SOLUTION TO POLLUTION IS DILUTION.

Investors should take a cue from environmental experts.

Avoid concentrating in a stock, industry, sector, asset class or country. We all know we should diversify.

Doing it by picking the things we think will do best seems to makes sense, but that’s wrong.

Diversification works not because you pick winners but because you select things that are different.

So, broadly diversify within and across asset classes.

Diversify stocks by size, between value and growth, and across countries.

3. INVESTING OVER TIME

Research shows that investing for the long term reduces investment risk because, even though the price of a given investment may rise and fall within a short period of time, it generally will gain back any losses over the long term. Investing over a lengthy period of time is the best strategy for long-term goals.

4. MONITOR YOUR INVESTMENTS

As assets gain or lose value, their balance may change and reduce the diversity of your portfolio. If the percentage of any asset strays too far from its target weighting you may need to rebalance your portfolio. This usually involves selling some of one asset type and buying more of another.

5. KEEP ASSET ALLOCATION CONSTANT

Tactical allocation changes the percentages each year to overweight in the asset classes expected to have the best returns and avoid the ones with the worst returns.

It sounds good, but it’s just another futile attempt to predict the future.

Keeping a constant weighting in your target asset allocation is a better long-term strategy than trying to outguess financial markets.

6. 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 stocks will increase in value.

7. BEWARE OF SCAMS

When markets are volatile scammers try to take advantage of investors.

Investment scams can come to you via a phone call, e-mail or social media.

They may even be an offer from someone you trust or who is introduced to you by someone you know.

8. PUT RISK IN PERSPECTIVE

Whether you're sampling a cup of steaming coffee or beginning the first day of a new job, you are encountering some form of risk.

Certainly no one should build an investment portfolio that causes one to lose sleep you must feel comfortable about your investment objectives and the methods you've chosen to achieve them.

Regardless of your investment goals, you can benefit from an understanding of risk.

Use proven risk management techniques and commit to your chosen investment plan, and you may find risk to be a valuable ally.

Cost averaging market conditions are hard to predict.

Trying to buy low and sell high can be challenging, and most investors fail to sustain any significant returns this way.

A more disciplined approach is cost averaging. With this approach, you invest a fixed sum of money at regular intervals, whether the market is up or down. The bottom line is all investments carry some degree of risk.

By better understanding the nature of risk, and taking steps to manage those risks, you put yourself in a better position to meet your financial goals.