There are two reasons to invest money. One is to keep pace with inflation, and the other reason is to grow it for achieving objectives such as purchasing a home or retirement. Apart from daily life expenditures, people need to have enough money to save for medical emergencies and for getting financially secure retirement. Many individualsin the initial years of their working life could not set aside money for savings. By the time a person starts earning enough, it is often too late to set aside adequate sums for retirement. Therefore, a method of allocating funds needs to be developed in which some of the investments in the portfolio are risky but would bring higher returns.
Risks scare most, but risk management techniques can manage or mitigate the risks in the courses. The simplest way of reducing risk is to study the asset in depth and analyze its potential before investing.
Purchasing insurances signify transferring of risk. Insurances in an investment portfolio, therefore, include accident, car, home, medical, and life insurance products.
Mitigating risks ensuring that the risk is limited. Therefore, investment in corporate shares has limited liability. In stock markets and other courses, the way to mitigate risks would be to have stop losses in place.
Opting for options is better than opting for longs and short positions which are without any options. The optionsgive a choice to walk out of the contract in whichever contract it is. Long implies investing in an asset anticipating its price to increase, whereas short implies selling an asset which the person does not have but selling it anticipating that the asset’s price would be southbound. If the anticipated decline does not happen, the person buying such a derivative contract would be forced to purchase the asset be it stock, commodity, or forex pair, etc., and surrender it at the agreed price. If, however, such a contract was purchased with an option to walk away from the contract, then the loss would only be to the extent that the investor paid for buying the option contract.
Investment Portfolio and Risks
Investment portfolio can be broadly divided into three categories; least risk, medium risk, and high risk. Government bonds and securities are least risky as would investment in a home or tax saving instruments. There is amedium level risk in mutual funds’ investments as well as in corporate fixed interest bearing deposits. The high-risk category would be shares including derivatives and risk management skills are essential for these.
Some of the investment risk management strategies are-
- Observe, analyze, and follow the direction of markets
It requires both patience and knowledge, apart from temperament to know when to book profit or loss. This can only come by reading and with practice.
- Redistribution of the resources and sizing
The process starts with savings allocation in particular proportions. This means approximately 1/3rdis set aside for risky investments and rest goes towards less risky investments. Since returns on risky investments would be higher, periodically skimming profits from them should be done, maintaining the ratios to the same levels.
In this context, it is important to size or divide the investments within riskier investments
as well. Some allocations can also be done with high risk and high return generating investments such as binary options.Binary Options area low investment and high return generating derivatives. An investor needs to predict the movement of the underlying asset class. There are variants of course, but usually, returns from this can be as high as 100 percent in a day. Correspondingly losses can be higher as well.
- Knowing the possible ways to reduce risks
Stop losses are systems to reduce losses, and can be used nowadays in almost all the trades. Basically, stop loss is defining the limit of loss that can be absorbed. Suppose an investor anticipates a stock that is quoted at $83 to touch $100and buys the stock, i.e., goes long on the stock without using any option. The investor is, however, not willing that the stock falls below $82, as the losses can be substantial in such case. Therefore, the trader restricts the losses by defining the stop loss as $82. Effectively, the investor may make a loss, but it would not be spiraling down loss as it used to be before contemporary technology came into the picture.
- Take advice, read, learn, and analyze
There cannot be enough emphasis on this aspect. Financial experts have mastered the art on how the markets behave, and when it would be advisable to hold on or sell the stocks. At times, they do go wrong, or they may have specified other conditions. It’s nice to listen to such experts, but it is also necessary to read about such advice from other sources and understand it. By reading and learning more about such advises and reasons behind them, it becomes easier to analyze the situation on the courses, and take decisions instantaneously, without the help of the experts.
This perhaps is the most commonly used risk management method, where all eggs are never put in one basket. Returns do come down, but losses will also be less. Diversification in stocks can be distributing assets among different sectors, and within each sector, between the various companies. There are indexes available with such diversified portfolios.
Taking risks in investments is almost a necessity these days for getting decent retirement corpus or for meeting any other objective requiring finances. There are also technologies and methods to earn higher returns from the various investment option sand reduce risks. Knowing about risk management helps to achieve those goals.