Smart investing includes risk management; however, most people focus on how much money they can make without paying attention to strategically analyzing risk.
It is important for an investor to fully understand the concept of risk before embarking on an investment plan and to implement certain safeguards to ensure their success rate is increased.
In investment terms, risk is associated with the end of period value of the investment and the primary concern for any investor is a reduction in value of the original sum invested.
There is no way of completely eliminating financial risk, even with the placement of assets in a bank account, therefore, a strategic investment plan should incorporate risk reduction techniques that have proven to create a greater opportunity of coming out ahead.
The most frequent techniques for reducing risk in investment are diversification, dollar cost averaging and time, and in order to better understand these areas we will expand upon their meaning and how they can be implemented.
Diversification Diversification in finance mixes a wide variety of investments within a portfolio and can include investing in different markets, regions or countries.
Diversification is a frequent practice of investment managers to reduce risk without substantial reduction in returns.
Diversification reduces risk because markets do not always move in tandem and many financial instruments will react differently to market conditions.
A balanced portfolio will be less volatile than one that is concentrated on a single asset and can include the following strategies: 1)Spread the portfolio among multiple investment vehicles.
2)Vary the risk in securities.
3)Vary by industry or geographical location.
4)Vary the investment managers and the strategies used by those managers.
Dollar Cost Averaging It is an investor's dream to be able to enter the market at its bottom but nobody can really tell when a market has ever reached this point.
In reality, we will often see people get caught at the top of the market instead of buying low and selling high.
Dollar cost averaging is a timing strategy of investing equal dollar amounts regularly and periodically over specific time periods and is a technique that prevents investors from putting all their money in the market at the inappropriate time.
Time as a Risk Moderator Time not only works for investors through the power of compounding but also helps to dampen the risk of investments.
If we look at most major markets, we will see that the stock market will usually follow an upward trend with interim fluctuations.
By focusing strategies on a long term basis, many of these fluctuations can be leveled in comparison to the overall performance as recoveries happen and markets will often surpass a previous high.
It is worth noting that there is no specific formula for time as a risk moderator and indefinite waiting periods could be considered when implementing.
For any investor, the primary step in the formulation of a successful strategy should be the setting of an investment objective.
Although "to make money" may be a fair representation of your goal, it does not focus on the strategic process that needs to take place in order to achieve what we have originally set out to do.
The investment objective must be realistic and specific and should take into account the risk tolerance, personal needs and circumstance and any constraints that the investor may have.
It is recommended that every potential investor carries out a financial needs analysis.
Many companies are available to help with this and provide the direction and equipment needed to carry out a proper analysis and most should carry this important service out free of charge.
It is also vital that any company that assists a potential investor with their strategy should describe these risk reduction techniques in greater detail and explain the ways in which they can be incorporated into an investment plan.