What Is Risk?
Risk is inevitable when you invest. There’s no way around it. Hence the key to maintaining a long and healthy investing track is not to avoid risk but to embrace it. This way, you can learn to manage it and have it work in your favor.
By definition, risk in investing means not knowing what will happen to the future. When you invest, there is always the chance that you might lose money — even if that chance is slim to none. Many amateur investors realize this early on and they tend to avoid this topic altogether. Perhaps they feel that risk is just an abstract concept, not something they feel comfortable understanding 100%. But experienced investors don’t shy away from the unknown. And they are also not risk-averse, meaning they don’t always choose the option with minimal risk. What they do is look at the bigger picture and carefully measure the level of risks they are comfortable taking. They then decide if those risks are worth the rewards they want.
So then how should we better manage risk? To do that, you need to first know how much risk you can actually handle. Try answering these 4 basic questions:
- If the market drops, how would you react?
- What will you do if the market goes up?
- How much money are you willing to lose?
- Are you willing to accept more risk level to achieve higher returns?
Only you can know the right or wrong answer to these questions. In the long run, knowing how well you can tolerate risk can help dictate your long-term investment strategy.
Equally important, you must also know that there isn’t just one type of risk. There are several and knowing how to navigate through them can differentiate an amateur investor to an experienced one.
Here is a list of a few types of risks you might face:
- Market Risk — This is the most commonly known type of risk, as markets are volatile by nature. Millions of investors buy and sell each minute of every trading day, which means that all stock prices are subject to change either for the good or the bad.
- Interest Rate Risk — This type of risk involves a change in an investment’s value due to fluctuating interest rates. In most cases, this risk is only applied to people who invest in bonds.
- Natural Disaster Risk — All investments are vulnerable to natural disasters. The best way to mitigate this loss is to diversify your portfolios across industry and geography.
- Political Risk — Political decisions and government policies affect the nature of companies’ profitability. Due to certain restrictions by the government, companies cannot distribute certain features to the public. This, in turn, affects their profits and their stock prices. For example, in the past QARA wasn’t allowed to make their trading options available because of strict regulations from the South Korean government. Thankfully, this all changed recently due to the regulatory global sandbox initiative — brought together by the Global Financial Innovation Network (GFIN).
- Emotional Risk — When you are putting your own money to something that is out of your control, you automatically feel anxious and fearful. But the important thing is to stay disciplined and not get sidetracked by these emotions.
Diversify Your Portfolio
One great way to manage risk and keep your investments alive for long-term is to diversify your portfolio. A well-diversified portfolio means you are investing in different types of securities from diverse industries. Having just one type of investment puts you at risk of losing all your hard-earned money. For example, the stock market from the Dot-Com Bubble Burst in 2000 lost over $8 trillion dollars of wealth. If your portfolio had stocks from only the tech industry, you would have lost more than 90% of your investments. Lesson learned — don’t put all your money in just one stock or industry.
There are several ways you can diversify your portfolio:
1. Choose a Variety of Assets — Having a wide range of assets not only minimizes risk, but it also increases the potential for future profit. Always remember that stocks aren’t the only investment vehicle you can invest in. You have cash, bonds, mutual funds, ETFs, real estate, and other funds to look into.
2. Go Global — Investing in firms from different countries across the world means you won’t be affected by the economic conditions of just one single country. While this is good, remember that some countries aren’t as developed and so their markets may be highly volatile. Take caution and know your risk tolerance before diversifying your portfolio by geographical regions.
3. Choose From Different Industries — Don’t choose to invest from just one single industry. There are thousands of sectors to choose from. If you have trouble finding which industry to invest in, check out KOSHO’s feature that includes portfolios from different sectors and regions, recommended by our AI deep learning technology.
Download KOSHO and diversify your portfolio by different sectors and themes.
4. Keep Adding — The best way to maximize your portfolio is to continue adding to your investments on a regular basis. Take each month or maybe several months to reassess your goal. Maybe your plan has changed and you want to shift gear to less risky investments. Or maybe you feel that your current portfolio feels too safe and you want to add a bit more risk. Regardless, continually adding to your portfolio is a good way to ensure that you are on the right track to becoming a successful investor.
Risk and investing go hand in hand. If there is no risk, there is no investing. To become a successful investor, you have to know your own risk tolerance and which types of risks are out there. The best way to avoid risk is to actually know about it. And perhaps not knowing about it can become the biggest risk of all in investing.