How to Reduce Risk

Reduce the Risk

 

There are ways to diminish the level of risk in financial investing, other than the obvious, to stay away from investing in the first place.

 

Don’t Put all Eggs in the Same Basket

The classic ways to spread the risk is to ‘not put all eggs in the same basket’. By investing in different securities, the risk of the whole basket (in investing the basket is called portfolio) will decrease.

 

Buy Securities that Hold Different Amounts of Risk

Regardless of your personal risk tolerance, buy some low-risk securities, some medium-risk securities, and some high-risk securities (these are called different security classes). Then weight the different security classes according to your risk tolerance. To the right are a few examples.

 

Below are examples of low- and high-risk portfolios. By buying several securities in each risk-segment (3 with high risk, 3 with medium risk and 3 with low risk) you lower the overall risk of the portfolio. By using this technique it's possible to lower the risk even in high-risk portfolios, and by doing so you can reap the benefits of high-risk; the possibility to win big.

 

   

 

Buy Several Securities in Each Security Class

Investors usually buy several securities in each class to allow one security to perform poorly without losing too much overall.

For instance, if you really believe in VR (Virtual Reality) and think that we will be able to use VR for all kinds of good things in the future, then buy a few different companies that develop VR applications. If one of the companies fail due to poor management decisions, running out of funds or another company specific reason, at least your other VR securities should do well and your overall loss will be much lower than had you invested in one VR company only.

 

Buy Cyclical and Counter-Cyclical Securities

Another popular way to diminish the portfolio risk is to invest both in cyclical and counter-cyclical securities. Some types of securities tend to decrease in price during recessions while others increase in value during recessions. If you buy both types of securities you won’t lose as much if a recession kicks in than you would have if you only buy securities that diminish in value during recessions.

A security type that generally does well in recessions is pharmaceuticals. People need their medicine no matter if it is a recession or not, and will buy it regardless. Typical recession-sensitive securities might be H&M and other fashion companies. When people lose their jobs in recessions they typically spend a lot less on fashionable clothes and instead use the ones they already have.

 

Buy at Different Points in Time

In the same way that investing in many different securities can lower the overall risk, so can buying the same security at several different points in time. If you do this, the chances that you unluckily bought your securities during a temporary high-peak are lower. Obviously, this also applies when selling securities.

 

Hold Over a Long Period of Time

The risk level is usually dramatically increased if you invest your money (buy and sell the securities) within a very short period of time, say 4 days, then if you are thinking to invest over a long period of time, say 10 years.

Take the Atlas Copco example from May 2015 (price 257.8 SEK) where you would have lost 30% had you bought at that time and sold the stock 9 months later. On the other hand, if you bought at the same time but instead held on to that same stock until June 22nd, 2017 (price, 339.8 SEK) you would have profited 31% on your investment. So, it usually (but not always) lowers the risk if you hold on to your securities for a long time rather than short time.

Still, it’s easier said than done to keep cool and not sell off a security when there is a big price dip. Many people have lost a lot of money because they sold off their securities in panic during big price collapses in the market, even if they intended to hold on to their funds for a long time. This leads us back to handling your emotions when investing and choosing the right risk-level for yourself.

2017-08-16

2017-08-19

Disclaimer: The information in this article, as all content on BlockBull Review, is not and should not be seen as investment advice. The information is for educational and/or entertainment purposes only, so use it at your own risk. It is possible to lose money when engaging in any investment including cryptocurrencies and past performance does not indicate future performance. Any opinions expressed are those of BlockBull Review's writers who are not broker-dealers or advisors of any kind.


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