Just because you are afraid of losing money doesn’t mean you should be investing now. Here are some easy tips to get a strong return and reduce investment risk.
Just 20 years ago, it felt like the working class was focused on 401K plans and gaining interest in savings accounts. Now, with the new world we live in, you are seeing any extra money earned by folks almost always being invested.
With inflation at an all-time high the last few months, cash is arguably the least valuable asset that you have. Even if you have all your money invested, you may be struggling at the moment to keep up with the eight and a half percent inflation rate over the last few months.
I’m a big proponent of remaining liquid, meaning that you have the ability to get to your cash quickly if needed. But I am also big on finding safe investments for a majority of the cash that you have saved. Even earning two or three percent on your money is better than the quarter percent it gets in your savings account.
Why is it important to keep quick access to cash? For some, it’s not nearly as important, but for me with two kids and a spouse, I never know what’s going to happen. My kid could go to daycare and break an arm and it could cost me $3,500 out of pocket. My furnace could go out in the middle of winter and after an emergency call, I could have to pay $7,000 for an entirely new unit.
I never like to live my life expecting the worst, but when it comes to money, sometimes it’s the best way. Expect and prepare for the worst and be thrilled if something good happens along the way – just smile and put some extra cash in your pocket.
Now, someone who is extremely conservative with their money and wants no risk will tell you this strategy is not for them. However, I am here to explain that if you do things the right way, you can reduce investment risk to basically zero.
Now, this type of strategy isn’t for someone who wants to be hands-off. If you are going to have a huge chunk of your liquid worth invested, it is something you will have to monitor. Follow these tips, and you can not only reduce investment risk but also reap the strong returns from a strong and diversified portfolio.
Actively Manage Portfolio:
Let me be clear, when I say actively managing a portfolio will help reduce investment risk, I don’t mean becoming a day trader. There is certainly a time and place for actively trading in your portfolio, but I’m just talking about monitoring it and learning the way your set of investments fluctuates on a daily basis.
This doesn’t mean that you can’t make any changes to your account, but I would also give every decision you make some serious thought before pulling the trigger. When you are heavily invested in the market, you want to make your risk tolerance on the low side vs. the high side if you just have a small piece of your assets involved.
The key thing to watch for is company news. In order to reduce investment risk, you want to have things spread out and if certain news gives a different risk tolerance to a current investment, you may want to realign.
You also want to watch for the winners and losers. Don’t bail on anything too quickly and don’t buy into success too fast, but if over time you see a certain investment doing really well, don’t be afraid to add more to it. At the same time, you can certainly pull away from items not performing up to your expectation.
Again, I don’t want this to seem like I’m telling you to micromanage your investment account, but if you are heavily invested, you do want to keep an eye on things at least twice a week to reduce investment risk.
Another key strategy to reduce investment risk is to have balance in your portfolio. This one is tough for me, it’s easy to find the hot trend and go all in. And while that can work for a short period of time, trends tend to cool off and you can easily get burnt as well.
A balanced portfolio means you have allocated your investment across a mix of different classes with different levels of risk. This means having a mix of mutual funds, stocks, and even bonds in your portfolio.
In order to reduce investment risk, you do have to give up some upside. This is a classic situation where you don’t get your cake and eat it too. If you want your investments to hit double-digit returns year on year, then you are going to have a lot of risk in your portfolio.
By having balance in your portfolio, you are not able to guarantee a profit every single quarter, but you are able to put yourself in a situation where you don’t need to worry about working until you are 75-years old.
Here are a few personal tips I have regarding balance:
- Look at the dividend percentage in a stock. In certain scenarios where a stock has a nice percentage dividend, the return isn’t nearly as important. And if the stock loses some value, you are still getting paid for being a shareholder. I have found a few that hover around the same share price but with a five percent dividend, they are moneymakers.
- Another solid place to start is Blue-Chip stocks. These are huge companies or corporations that have great reputations amongst everyone. These companies have extremely dependable financials and typically have a strong dividend as well. You may not get a return of 10% year on year, but you also have very little risk of losing any of your money. You don’t want your entire portfolio tied up with blue-chip stocks that may struggle to hurdle inflation, but having a portion in your book can really help reduce investment risk.
- The hardest rule for me to follow – don’t just fall in love with stocks. No one knows for certain what is to come, but it definitely feels like a market reset is on the way. Stocks will always come back (typically), but now is a time to consider something like a bond that could start having higher values than stocks with interest rates going up.
Often when people think about investments, their minds only turn to stocks. Another challenge I have for folks is to start thinking outside the box. And while it takes more capital, another fantastic investment strategy that can help reduce some risks is real estate.
You can purchase a house and rent it out and turn a nice profit each month. Not only are you making money off the rent, but the asset will also retain value and at some point, when you are ready to sell, you should likely get a similar amount as the price you paid which is the classic double dip return.
Don’t get me wrong, real estate certainly comes with risk. But if you have a portfolio with a combination of investments and not just one type, you can reduce your investment risk by a sizable amount.
Timing is Key:
One of my favorite quotes from Warren Buffet is, “Be fearful when others are greedy and be greedy only when others are fearful.” If you look back in time, that could not be more true.
Here are two recent examples that I caught myself in. Recently, Google and Amazon announced a stock split. Both are extremely high priced that can often be found at over $3,000 per share. As soon as the split was announced, my mind went to it becoming more affordable for everyone to buy, and to get more before the split.
Well, everyone else had the same idea, so to buy then you were really just getting it at an overvalued price. It is often so appealing to buy when things are hot and to sell when things go cold. So to capture the perfect timing, the best advice I have is to do some research and see how the stock is valued and see if the timing is right.
A stock is thought to be overvalued when its current price doesn’t line up with its price to earnings (P/E) ratio or earnings forecast. If a stock’s price is 50 times earnings, for instance, it’s likely to be overvalued compared to one that’s trading for 10 times earnings.
The opposite goes for an undervalued stock. If you see a P/E ratio that is extremely low, it can be an undervalued stock and a perfect time to buy. The lower the P/E, the better, because you’re paying less for the amount of profit the company is able to generate.
All of the items I’m going to talk about today are important and can help you reduce risk, but timing is likely the most important factor that can really help you out.
Do Your Homework:
Don’t get me wrong, if you want to earn high returns, you will be taking some sort of risk with investments, but it’s your job to make these calculated risks. When you are in control of the math, you then can decide how you want to reduce investment risk in your portfolio.
What do I mean by doing your homework? You should be doing research on any company before you decide to invest in it. I know that seems like a lot of work, especially if you are only investing a small piece in a company, but that is just what it takes.
I’m not saying you need to read the entire 10K report from the last three years, but a quick Google search and history of their stock performance can tell you a lot. You will also see if there are any rumors in the market that will increase or reduce investment risk in the near future.
If you are working to reduce investment risk, you should be worried about buying into a fantastic company, and not worrying about the price as much. Getting a fantastic price on a mediocre company can provide higher returns but come with far more risks.
Remain Somewhat Liquid:
You have heard me say it at least one hundred times in past articles, cash is the least valuable asset you can have right now. However, in order to reduce investment risk, one thing you can do is keep your overall portfolio sufficiently liquid. That means you have access to cash quickly in case of some sort of emergency.
Having access to cash will also keep you more flexible in new investments. I have already covered that you don’t want to just be buying and selling, constantly trying to day-trade, but you also need to be prepared at all times for the proper time to buy. If you have all your funds tied up, it can make timing the market that much more difficult for you.
Liquidity is obviously cash, but typically a brokerage account will also give you access to your cash almost instantly. Meaning if you make a trade to sell, even if the trade hasn’t been finalized, you have access to that cash immediately for repurchasing or transferring back to a checking/savings account.
The amount of liquidity you have available is going to be different for everyone. If you want to reduce investment risk as much as possible, I suggest having at least four months (cost of living) available in cash. I’ll be honest, I operate closer to two months because I like to get some return on my money.
It doesn’t matter if you are a first-time investor, or you have been making trades and purchases for years, there is nothing wrong with finding ways to reduce investment risk. Everyone is different and everyone has a different risk tolerance they are comfortable with.
The one thing to remember is that you can’t eliminate all risks when it comes to investing. But you can reduce that risk if you follow the steps above. If you are someone that loses sleep at night over investments going south on you, I would highly recommend speaking with a financial advisor. There will be a cost for their services, but it is just one more layer of expert opinion to help you navigate risks within your portfolio.