No matter how stable you might think an investment is, there’s always a certain amount of risk attached. However, smart investment is all about minimizing your risks while maximizing your returns. And this is where portfolio risk management comes into the picture. It involves identifying, assessing, measuring, and mitigating the risks associated with an investment. Starting from the very first investment, it lasts through the entire lifespan of a portfolio.
Read on to discover essential risk management strategies that should be common knowledge for every investor:
1. Diversification
Diversification is a common investment strategy used to minimize risk. It has to be the first step in building a portfolio. Investment capital is divided between asset classes such as bonds, stocks, real estate, cash deposits, commodities, and treasury bills. Each asset class must be diverse in itself as well. For example, when buying bonds and stocks, you must spread out the capital among different industries rather than parking it all into one.
2. Asset Allocation
In basic terms, this is all about determining the percentages of each asset, depending upon your risk appetite. The amount of risk you can take depends on both age and lifestyle. An investor in their 20s can afford larger risks owing to retirement age being far off. High-risk investors go for fast-moving, risky, but rewarding assets like equities. Low-risk investors should stick with less rewarding but risk-free assets like treasury bills and government bonds.
3. Time Horizon
You can’t hold an investment forever, now can you? Duration is categorized into three terms: short-term, held for less than 5 years; mid-term, held for 5 to 10 years; and long-term, held for over 10 years. The duration is also dependent upon investment objectives and goals. Long-time horizons enable investments to grow steadily.
Before We Sign Off…
Remember that taking decisions based on emotions is the biggest mistake you can make in the investment world. If you’re too invested in a particular portfolio, rumors can get to you. But, do not make any moves before conducting a risk analysis. You can also use tools like stop-loss to save your stocks. Whatever it is, think about your decisions clearly before acting on them.