Investment can be an excellent way to boost your wealth and achieve your financial objectives. However, there are risks associated with investing. If you are not extremely careful, you may wind up losing a large amount of your hard-earned money. This is where investment risk management comes in. Nevertheless, you can reduce your risks and boost your chances of success by applying appropriate investment risk management tactics. In this article, we will look at how skilled investment risk management may help you enhance your investment results.
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What Is the Investment Risk?
Investment risk is the degree of uncertainty in achieving the expected return of an investor. It is the extent of the outcome that investors cannot predict. Investment risk is an important element in evaluating investment opportunities. Most investors think that the less the risk, the better. However, in the investment market, it is well known that high-risk investments can give a high return as well.
Where Does the Risk Come from?
In fact, investing in each asset type tends to have different investment risks. However, risks are mostly divided into two main categories as follows:
Systematic risk, or market risk, is a risk that may affect the market or the overall economic sector. Examples of systematic risk are political factors and macroeconomic factors such as interest rates, inflation, deflation, etc. If the economy is good, asset prices will increase. At the same time, if the economy is in a recession, asset prices will fall. These are often inversely proportional to market forces.
The unsystematic risks, or specific risks are risks that affect the industry or only one company. An example of unsystematic risk is industry trends. If any industry is in an uptrend, industry asset prices will increase. Moreover, company performance is largely dependent on the type of business, products, services company strategy, as well as the ability of the executives. Importantly, this performance is a variable directly related to that company.
What Are Investment Risk Management Principles?
Investment risk management is the process of managing factors and controlling activities to reduce the potential cause of investment damage. This risk has to be managed in order to retain the level of risk and impact at a level that investors can accept and control.
3 Investment Risk Management Principles
1. Asset Allocation and Diversification
In the investment market, investors should not invest in a single asset class. The reason is that if there is a crisis, investors can lose all their money. Thus, investors are advised to combine different asset classes to diversify their investments. Investors can diversify their investment into various assets such as bonds, stocks, gold, oil, and real estate. If investors are unable to diversify across assets, investors may consider diversifying into other industries under the same asset class.
However, the allocation of investment assets should be based on the acceptable risk of each person. Moreover, funds for asset allocation must also be considered. Diversifying the investments allows investors to minimize the risk of massive losses. It can arise from overemphasizing a single asset class.
2. Investing Consistently
Regular investment or dollar-cost-average is another way to reduce investment risk. This is because asset prices can fluctuate all the time depending on different factors. Importantly, all of them are difficult to predict. Therefore, if investors buy that asset regularly every month, investors will be able to purchase such securities at the average cost price throughout the investment period. Investors can invest without worrying about market price fluctuations. Furthermore, investors can eliminate the risk of mistaking timing.
3. Long Term Investment
A long-term investment is another way recommended by experts. In fact, short-term investments tend to face high volatility. However, if investors invest long-term, they can help eliminate the risks that may arise. This is because assets are usually growing in the long term. Finally, this causes asset prices to rise. In addition, long-term investments tend to yield higher returns than short-term investments. The recommended period is from 3-5 years or more.
In summary, investment risk management is a method that allows investors’ portfolios to generate good returns in the long run. It can reduce the chance of loss to a minimum. Investors can manage the risk by diversifying their investments with the dollar-cost-average method as well as investing for the long term. Finally, these will allow the investor’s portfolio to reduce the risk from various factors.
Assessing your financial goals, time horizon, investment experience, and emotional capacity for risk are all methods to determine your risk tolerance for investing. To further understand your risk tolerance, you can also complete risk tolerance examinations offered by financial institutions or talk with a financial counselor.
Your investment goals, risk tolerance, and market circumstances all influence how frequently you should rebalance your portfolio. Several financial advisors advocate rebalancing your portfolio annually or semi-annually as a general rule to ensure your portfolio remains aligned with your investing objectives. However, other investors may decide to rebalance more often, such as quarterly or even monthly, to capitalize on short-term market movements or resolve substantial portfolio imbalances.
Unfortunately, it is not possible to eliminate investment risk. All investments are risky, with the danger of losing all the money invested. However, diversification, asset allocation, and other risk management measures may manage and mitigate investment risk.
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