By: Patrick Lyte, Financial Planner, The Financial Network
Effective risk management contributes to successful investment, this is because, risk (which is by definition the possibility of incurring financial loss) is a common and inherent of any investment opportunity, product and/or instrument. Thus, knowing and understanding the level or risk and exposure you are willing to take with your investments should be very important to you as an investor.
It is common for inventors to minimize risk in their quest to obtain maximum gain. The extent of risk an investment is exposed to will vary depending on the grade and type of the investment instruments, product or opportunity; which could vary from extremely low risk or risk free instruments (U.S. Treasuries issues, bank CD’s), to extremely high risk securities (i.e., stocks, commodity futures contracts, derivatives).
Managing Investment Risk: Managing investment risks is a technical task that is best suited for investment professionals in this highly challenging and complex market place; however, that said, identified in this article are some key factors, and elements, you can use in your efforts to facilitate management of investment risk and they are as follows:
- Establishment and maintenance of investment policy guidelines and procedures that outlines clearly:
- Your primary/secondary investment goals, objectives, and performance expectation; the length of time the funds will be invested. (long/short-term time horizon),
- Your Investment Risk Tolerance – Determining, knowing how much risk an investor is willing to take and/or expose their investments to is a critical first step; which should help to establish a comfort zone which in turn tend to reduce anxiety – Know as the sleep well at night test.
- Development, implementation of effective investment strategies and action plans; such as employing asset diversification and allocation manage and mitigate investment risks and exposures.
- Diversification – Not having all of your eggs in one basket is an old adage and simple way to articulate the process and objective of risk management. Diversification is important to managing risk and we strongly advises and encourage our clients to build and maintain a diversified investment portfolio by asset class/type risk exposure, market, industry sector etc.
- Targeted Asset Allocation Parameters – Asset allocation has proven to be an effective means to mitigate and manage risks and exposures associated with investments in: equities (i.e., stock market risk, price fluctuations and volatility); bonds market and fixed income securities risks, (valuation/price changes, interest rate, credit/default risks), Commodities, derivatives and futures markets risks, fluctuations and volatility. Asset allocation involves the process of setting targeted ranges that represent along-term view of an investment portfolio, however; short-term market volatility may from time too time cause the asset mix to fall outside the targeted range.
- Due diligence – Exercising due care in the selection of investment, products, instruments and opportunities, careful identification, thorough research will contributes to sound judgment. This process should include: an assessment of your financial status, resources and the funds available to invest; seeking and obtaining advice and guidance from credible sources; and, monitoring and assessing performance, in your efforts to make well informed the decisions.