Stock Market Basics: Seven Ways to Limit Investment Risk
Any individual thinking about investing has to consider the risks associated with investing in an entity or company that is no sure thing. Some investors find the thrill of risk vs. reward to be too exciting to pass up. Other investors will simply lean on investments with limited risk like bonds and certificates of deposit. Investors will wonder what they can do to help them tackle the investment risk mountain. Some commonly used strategies include:
1. Understanding Your Financial Picture: Before you invest in anything, you need to ask yourself "Can I afford to lose this money"? If the answer is no, then you should hold off on investing. There are individuals who will actually put money towards investing while they have substantial debt, whether credit card debt or loan debt. It is strongly recommended that you clear all debt before investing. You are only putting yourself at further financial risk if you are investing while in debt.
2. Understanding What You Can Afford to Lose: If you answered Yes to the question above you now need to answer another question. "How much can I afford to lose"? The amount you have chosen can be your starting point for investing, which can be changed later. You don't need to invest all of this money at once or even in the same investment tool. Investors should first cultivate ideas.
3. Cultivating Ideas: Have you ever heard of Warren Buffett? If you have, you know one of the things he recommends doing is reading through an annual report of a company you are considering investing in. This strategy gives you financial info and helps you decipher the main players in the company. Knowing as much about an investment as you can is the best way to make an informed decision, but don't go investing in sectors you know nothing of. For example, if you work in the technology field, investing in technology companies would be a good idea, but if your knowledge of the financial sector is poor, it may be best to avoid it until you've done more research.
4. Diversify: So you've set up your investment account, determined what you can spend and have some ideas on the investments you'd like to purchase. So you're good to go? Not quite. The best way to limit your investment risk is by diversifying your portfolio. This means you need to have a combination of investitures such as bonds, stocks, ETFs, mutual funds, etc. to limit your risk. You can also consider investing globally if you're familiar enough with other markets. Why do this? A stock in the US you invested in may take a nosedive; if that is all you've invested, in your money is lost, but if it is only 15% of your portfolio and your other investments are doing well you can afford to take the hit.
5. Time is Your Friend: The only reason you should be taking away from your investment pool is in case something goes severely wrong and you need the liquidity to pay your bills, etc. This doesn't mean you can't sell a stock for profit, but rather don't take everything you've spent out unless you absolutely need to. Otherwise you should continue to add to your investments as you can afford to. The longer you have invested, the more likely it is you will see returns.
6. Avoid the Theory Train: It is okay to watch television programs related to investments and read up on what the experts are saying, but don't use this as your sole reasoning for making an investment purchase. These pundits are attempting to describe what is happening based on that day or that week. You on the other hand may be looking at ten years from now. So what if a stock went down five cents today? If you own it for the long haul, it might be up five hundred dollars in ten years.
7. Keep a Watchful Eye: You should be watching how your investments are performing. You can do this daily, every few days, weekly or whenever you choose to, quite frankly. Make decisions based on patterns. If you've been watching a stock you own climb by 200% over the past few weeks it may be appropriate to sell off a few shares and reinvest it elsewhere. Remind yourself you aren't day trading, you don't need to make a profit every single day due to your long term goals.
Utilizing these strategies while investing should help in limiting your risk, but remember that when investing there is always some risk potential. These strategies will only limit risk, not eliminate it.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.