Risk is an integral part of any investment. Regardless of your actual risk tolerance, every investment carries some measure of risk. However, there is much that investors can do to manage risk within their investment portfolio as a whole.
I recently interviewed Ramsey Brock, president of Brock Asset Management, who offered some key strategies that investors can use to more effectively manage their risk.
1. Invest Based On Your Risk Tolerance and Goals
“Investors should always start by assessing their risk tolerance and goals — namely, whether their investment portfolio aligns with their risk tolerance, and whether that risk tolerance is a good match for your financial goals,” Brock says.
“If you’re saving for retirement, you’ll generally have a higher risk tolerance when you first open your account, but you’ll need to take a more conservative approach as your retirement date nears. Your risk tolerance and portfolio mix should be reassessed regularly to ensure they align with your current situation.”
This is part of why target date retirement accounts are a commonly recommended option, as they automatically adjust their portfolio mix as the retirement date approaches. Other accounts should similarly be re-evaluated as your goals and financial situation change to ensure investments match your risk tolerance.
For investment portfolios that aren’t part of an automatically managed target date account, getting a professional portfolio analysis may be beneficial in ensuring that your portfolio is properly balanced for your current needs. This can help you understand how different assets offset or complement each other, as well as what type of reallocation may be necessary to better align your portfolio with your needs.
2. Focus On Staying In for the Long Term
Brock also recommends that investors maintain a long-term focus. “It can be easy to get distracted by the day to day ups and downs of the market, but investing should always be looked at as a marathon rather than a sprint,” he says.
“You should consider how your portfolio is performing over time and what its long-term prospects are. Getting in early and staying in for the long term helps manage risk because you ride out short-term trends and enjoy the power of compounding interest to grow your money more. The earlier you can start investing and the longer you can stay in the market, the better your growth will be.”
While the stock market’s overall returns vary from year to year (and include occasional downturns), the market has delivered an average return of roughly 10% per year for decades. Keeping money in as a long-term investment for five years or more is a simple way to manage risk and increase your likelihood of getting these positive returns.
3. Avoid Emotional Investing
A focus on staying in for the long term also helps address another common element that can increase risk in your investing portfolio: making emotional decisions. “It can be all too easy to let emotions take over your investing decisions,” Brock says.
“Whether it’s something you see in the news or on social media, something that gets your emotions going could cause you to try to time the market by buying or selling a position at what is ultimately the wrong time, or by investing in an asset that isn’t a good fit for your portfolio. These emotionally-driven actions usually backfire and cause you to lose out on portfolio growth you would have achieved if you had simply stuck with dollar-cost averaging. Taking emotion out of your investments is one of the best ways to manage risk.”
Dollar-cost averaging is what Brock recommends as a tactic to avoid emotional decision-making. With this investment strategy, a fixed amount of money is invested into the portfolio or a specific asset at set intervals, such as once a week or once a month. Rather than trying to buy low and sell high, and unintentionally doing the opposite, this strategy results in consistent contributions that ensure steady growth.
4. Consider Stop-Loss Orders
For investors who are particularly worried about the potential for significant losses, Brock recommends considering a stop-loss order. “A stop-loss order is an order that causes you to automatically sell your position in a stock when it falls to a particular price,” he explains.
“The idea is that if a stock starts dropping significantly, you will be able to automatically sell your position before it drops below a level that would cause major damage to your portfolio. This strategy can be helpful for those with a lower risk tolerance, as well as those who want to reduce potential losses when investing in a high-risk asset. This ensures you won’t lose more than you can afford to lose.”
While stop-loss orders can be beneficial when applied to individual stocks, it’s also worth noting that a diversified portfolio that is appropriately balanced between a mix of asset types and positions can minimize potential losses linked to a single stock or asset.
Managing Risk Appropriately
While investing is never entirely without risk, there are steps you can take to better manage risk within your investment portfolio. By implementing strategies that align with your risk tolerance and general best practices for investing, you can avoid common mistakes and remain focused on achieving your long-term goals.
