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How to reduce your investment risk
Protect your money by diversifying and planning for the long term.
Regardless of how you choose to invest your money, from trading it in the share market to keeping it tucked away in a bank account, there are risks involved. If you’re nervous about losing money in your investments, consider ways to ease your risk.
What is investment risk?
Investment risk, or risk of financial loss, comes with almost all investments. When you decide to invest, you’re never guaranteed a return on that money. In fact, you could even stand to lose the money you initially invested — and sometimes more, if you’re trading products like CFDs.
Types of investment risk
There are different kinds of risk you may take on when investing. So it’s important to be aware of these.
Business risk: When you invest in a stock, you’re betting the company tied to it is going to profit. This isn’t always the case, which is why you should carefully review the fundamentals and financials of a company before you invest in it. You can find many important details on their balance sheets, which you can typically find on their websites. You’d find facts like the company’s revenue, debt and more.
Credit risk: If a company or government can’t pay its debt, that’s bad for their investors. Credit risk is especially important for bond investors. But you can turn to credit-rating agencies like Standard and Poor’s, Fitch and Moody’s. These firms rate bonds from good or investment grade to risky like junk or high-yield.
Volatility risk: Even when companies are performing well, their stock prices can dip substantially due to uncontrollable factors like the overall state of the economy. One effective way to hedge against volatility risk is to diversify your portfolio by investing in different types of securities. When one falls, the loss can be offset by the ones performing well.
Political risk: Also called geopolitical risk, this is the risk that a company’s financials will crumble due to massive political changes in the country. This can come from changes in leadership, war, economic turmoil and more. It can especially affect emerging market stocks. So it’s a good idea to keep an eye on the overall state of countries you’re invested in.
Inflation: The increase in prices of goods and services or inflation can have a negative effect on investors. Inflation can drain the pool of money you have to invest. And because of its effect on interest rates, it can reduce returns from bonds and other interest-based investments. Some investments like gold, real estate investment trusts (REITS) and Treasury inflation-protected securities (TIPS) are believed to hedge against inflation. So it may be a good idea to keep a portion of these in your portfolio.
Strategies to reduce your investment risk
Use one or a combination of the following strategies to help reduce your risk when investing. The more of these strategies you use, the lower your risk could be.
- Understand the different asset classes
- Diversification between asset classes
- Diversification within asset classes
- Research before you invest
- Balancing risk and reward
- Investing for the long term
- The dollar cost average strategy
1. Understand the different asset classes
The first and possibly most vital step to reducing your investment risk is understanding what it is that you’re investing in. Different investments are categorized under asset classes, each with a different level of risk.
For example, equities — which includes US and global shares — are considered one of the most high-risk of all asset classes, usually followed by property. On the other hand, cash — including bank deposits in products like savings accounts or term deposits — is seen as the least risky asset class, followed by fixed interest (e.g. corporate and government bonds).
- Key takeaway. Understanding the asset classes helps you design an investment portfolio that matches the level of risk you’re comfortable with.
Learn more about investment asset classes.
2. Diversify between asset classes
To avoid putting all your eggs in one basket, diversify your investments across a range of asset classes. This is less risky because each asset class behaves differently.
For example, if the property market is doing poorly, it’s possible the stock market could be strong. If you’re only invested in one asset class, and that asset class does poorly, your entire portfolio will suffer.
You don’t need to invest in every asset class, but investing in two or more asset classes, at different amounts, can help reduce risk.
- Key takeaway. Spreading your portfolio between different asset classes can help balance your investments when one asset class suffers losses.
3. Diversification within asset classes
Diversify your investments within each individual asset class to reduce your risk of losing. So with the portion of your portfolio in equities, make sure you’re invested in a range of different types of stocks. Invest in shares from different sectors like healthcare, financial companies and renewable resources as well as different countries like US and European stocks.
- Key takeaway. Don’t invest solely in Apple or Amazon alone when picking tech companies to buy stocks in. Instead, use an investment account to purchase diverse stocks within one asset class.
4. Research before you invest
One of the main strategies to reducing your investment risk is to do your research. Investing in assets with little thought, or investing in something based on rumors or speculation from others, is a sure-fire way to increase your risk.
Here are a few easy ways to research potential investments:
- Follow the news. Read the financial news in the morning or listening to the market updates on the radio on your way to work. You’ll get updates about the economy and how asset classes are performing.
- Read annual reports. If you’re investing in shares, read the company’s annual reports to get an idea of how the company is performing and what its plans are for the future.
- Do online research. Check out websites and blogs that follows the market.
5. Balancing risk and reward
It would be nice if you could earn high returns while taking on little risk, but unfortunately investing doesn’t work this way. It’s typically understood that the higher the risk, the higher the potential reward. So to earn a return on your investment, you’ll need to take on a certain level of risk.
Exclusively investing in low-risk products like savings accounts won’t give you a big return on your investment. On the other hand, investing exclusively in high-risk shares could get you much higher returns, but there is a chance you could lose your investment.
- Key takeaway. Find the right balance and weigh your risk. Start by considering the your end goal — what do you hope to get out of your investments? Determine what success looks like for your portfolio, then work backward to find the investments that will get you there and the amount of risk you need to take.
6. Investing for the long term
Another way to reduce your risk is to invest with a long-term mindset. Investments, like shares, can be very volatile, often rising and falling by a significant amount in a month or less.
But if you’re invested for the long term, say 10, 20 or even 30 years, you won’t be as bothered by short-term market movements. A lot of high-risk share portfolios predict the high returns they’re aiming for after seven to 10 years, despite ups and downs along the way.
- Key takeaway. Your portfolio, and your returns on your investments, are personal to you. It is easy to get caught up in short-term gains, but don’t be afraid to plan 10, 20 or even 50 years into the future when looking at the potential of investments.
7. The dollar-cost average strategy
The dollar-cost averaging strategy is a way of buying small shares of the same asset gradually over time, rather than buying it all at once. For example, if you wanted to invest $20,000 into a renewable energy stock, instead of buying it in one hit, buy $2000 worth of the shares each month for 10 months.
This means that you’re not picking a certain share price, opening you up to the risk of buying them at a bad price. Instead buying the shares in smaller parcels over a longer period of time, the average price of your shares are a lot more accurate and closer to the true share value.
- Key takeaway. This strategy helps reduce the risk of buying the shares at a bad price. But it means that you’ll pay more in brokerage fees when you pay a brokerage for each trade. The dollar-cost average buying strategy is more worthwhile when you’re investing large amounts of money.’
Compare stock trading platforms
If you’re ready to start investing in stocks, ETFs, bonds and other securities, start by comparing brokerages to find one that offers the investments you’re interested in.
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Determine the level of risk you’re comfortable with, do research and follow the markets to find out where to put your investments.
If you’re unsure of how to do that, or you don’t know where to start, head over to our guide on investing to begin building your knowledge.
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