Investment risks are a given if you expect to make any money in the stock market. But you can still be smart about the risk you take on.
There are plenty of monetary risks around a pro football game. Player salaries and stadium expenses are but a couple. Within the game itself, though, we don’t usually think about investment risks. But in 2010, at Super Bowl XLIV in Miami, the New Orleans Saints made a big investment, and it was incredibly risky.
At halftime, the Saints trailed the Indianapolis Colts 10-6. The odds were in the Colts’ favor. Then came one of the most famous plays in Super Bowl history. The Saints made an onside kick to start the second half. After a scramble for the ball, they gained possession, and went on to score a touchdown, putting them in the lead. Ultimately, they won the game, too. But the investment they put into that single play was a huge risk. If they hadn’t recovered the ball, the Colts would have been in position to score again, almost certainly sealing the deal in their favor.
Similar to investment risks with actual money, the Saints could have lost everything. The investment in that play happened to pay off, but when it’s your portfolio, you probably want some assurance that the results will be in your favor. Both in sports and in real-life investing, there are some big potential rewards for taking on larger risks, but it’s one thing to lose a game. It’s another thing entirely to watch your retirement fund crumble. And in turbulent markets, that can happen all too easily.
Are any investment risks worth taking?
Investment risks are a fact of life, and are neither 100% good nor totally evil—they’re a necessary part of investing. Without risk, there would be no reward. The important thing is to know how to plan for and manage it.
Successful investors always consider investment risks when they analyze their portfolio, adhering to rules like cutting losses short or diversification. Even in the best of times, you want to consider how much of your hard-earned money you have at risk, and how you’ll handle your stocks should they head south.
Diversification is an easy way to handle risk. The more holdings you have, the lower your risk. If you have 50 holdings, it will be hard for the failure of any one of them to deep-six your results.
The problem is that it will be correspondingly difficult for a big rally by one of your stocks to make you a lot of money. For maximum results, you need a concentrated portfolio. And when markets are challenging?
You slow down, pulling money out of aggressive growth stocks. You hold a lot of cash on the sidelines, waiting for the weather to improve. And you constantly take stock of your position, monitoring each holding in your portfolio to ensure that it’s not putting your financial future at risk.
10 Tips to limit investment risks (and maybe even find a few stocks for your portfolio)
1. Don’t obsess over the why.
When you’re making investment decisions, 100% of your focus should be on facts (market trend, fundamentals, price and volume, etc.) and not opinions or news.
2. Avoid low-priced stocks.
When you buy a low-priced stock, particularly one with low trading volume, what you buy is higher risk. Risk is higher because these stocks are unproven.
3. Don’t avoid high-priced stocks.
High-priced stocks get that way by being successful, and that there’s nothing wrong with buying just a few shares of such a stock
4. Diversify—but don’t overdo it.
This is the oldest rule in the book, and there’s a reason for it. Nothing is certain. Even the best companies and stocks can be brought down by unexpected events. But too much diversification, as noted, will stunt any growth opportunities.
5. When investing in growth stocks, watch the charts.
Everyone likes a good story, but savvy growth stock investors require their stocks to also be in confirmed uptrends.
6. When investing in value stocks, watch the value.
Again, a good story can be attractive. But unless you see the valuation explained with clear, cold numbers, it’s just a story and not a value.
7. Good stocks can go bad in a hurry in bad markets.
This is the key reason why you should keep any buying to small sizes in a downtrend—today’s potential leader can be road kill tomorrow.
8. Use a proven system to find “bargains.”
It’s important to understand that just because a stock is down 20% in the past month doesn’t mean it’s “cheap” or a bargain.
9. Bottoms are usually a process, not an event.
In the vast majority of the corrections, market bottoms are a process, not a one- or two-day event. Instead, you often see one or two retests or at least some bobbing and weaving. So before you jump into the market anticipating a big increase, keep in mind that the odds are against the first low leading to a sustained advance.
10. Remember—big money awaits!
The big money is made in the big swing, owning a good-sized position in a new (usually little known) leader near the start of a new sustained market advance.
You can’t invest in the stock market without some investment risks, but if you play smart, and focus on the long term, you can limit your risk while still putting yourself in a position to make big gains.
What are your thoughts on investment risks? How much is too much? Share your ideas in the comments below.