5 ways to lower investment risk
The word ‘risk’ can mean different things to different people. Some are instantly shy of risk when it comes to investing and can miss out on a host of opportunities. At the opposite end of the spectrum, some may take unreasonable risks to try and make a quick profit and get financially damaged.
The truth is that between these two extremes there is a rational way to use growth investments to help you create a portfolio with real potential and genuine resilience. Here are some top tips for how to go about it.
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Leave ‘picking winners’ to the punters
Let’s get one thing clear right off the bat; investments should never be treated as a gamble. If you invest in shares, for example, with the hope of a quick win, then the chances are you will lose. There is no magical investment opportunity that is going make you rich in the short term without a significant chance of you losing money.
Some will enter the share market on the basis of a ‘hot tip’ on a particular share hoping to make a quick gain. More often than not such an approach will end in disappointment. Growth investments need to be used in a strategic and judicious way based on your medium to long term goals.
Diversify to dilute risk
The key to utilising growth investments, such as shares and property, is the age old rule of not putting all your eggs in one basket. Different markets and industries tend to go in cycles and when one is up, the other may be down. If anyone was able to predict the fluctuations accurately all the time, then they would be very rich indeed, but investors need to live with the reality that this is simply too difficult. That’s why it’s essential to spread investments across a diverse range of asset classes, countries, sectors and styles, so that you capture growth and mitigate downside by not relying on just one narrow choice.
Of course, diversifying is not simply done in a scattergun approach. It needs to be done strategically, based on sound research, an informed analysis of the markets and with proper regard for your lifestyle goals and timeframes.
Balance growth and liquidity needs
A rule of thumb with growth investments is that they need time to deliver results. Share markets and property will generally outperform cash type investments over the longer term, but they will usually have a lot more fluctuations along the way. The best way to use them, therefore, is to be prepared to leave those investments invested for the medium to long term.
This means that when you are devising an investment strategy you need to be realistic about when you will need to access funds for essential spending. If there is a high likelihood that you will need to access funds in the short term for income needs or purchasing major items, then use cash and fixed interest investments that have a more predictable return in the short term to cover those needs. Without the pressure to cash in your growth investments at short notice, you then have the freedom and flexibility to only liquidate those investments when markets are favourable.
Pooling your investments can help
Investing by yourself directly into property or shares is limited by the capital you have to invest. By pooling with other investors through investment vehicles such as managed funds you can achieve a “critical mass” of capital, which opens up opportunities that are simply not available to the solo investor.
For example, instead of just one investment property, your money can be spread across a whole portfolio of residential and commercial property via a managed property fund. Or instead of one parcel of shares in one company, your money can be spread across an array of shares in various world markets, via a share-based managed fund. Managed funds not only spread risk more broadly, they also give you the benefit of the investment manager’s expertise.
Use a financial planner to achieve the right balance
The important first step in forming an investment strategy and managing risk is to have a thorough assessment of your personal and lifestyle needs. This is where a professional financial planner can really make a difference. They are trained in helping you to clarify what you want to achieve in terms of lifestyle and financial independence. A financial planner can then apply a systematic approach to select the right investment mix to meet your specific goals and timeframes. Using a financial planner helps you objectively build a sound and effective strategy, rather than simply relying on guesswork.
A financial planner also offers you the advantage of having the time, skill and resources to actively review your portfolio and recommend adjustments, so that your investment mix does not get out of balance with your goals. This can relieve you of the worry involved in managing a portfolio.
How do you feel about investment risk and the use of growth investments in creating a portfolio? Share your ideas below.