In the world of finance and investing, the pursuit of profit often goes hand in hand with exposure to risk.
Whether you’re a seasoned investor or just starting your financial journey, understanding and effectively managing risk is crucial for long-term success.
In this blog post, we’ll explore the fundamentals of risk management and practical strategies to safeguard your investments and navigate uncertainties with confidence.
Risk Management Tactics
Have An Emergency Fund
Make sure you have an readily available emergency fund set up before you begin investing. This will prevent you from needing to sell investments at a loss during unexpected financial emergencies.
I keep mine in Worthy because it pays like a fixed-income asset, but is as liquid as a savings account. You can begin acquiring bonds with just $10. This money helps fund small businesses, which is awesome.
It pays 5.5% (5.73% APY) interest and your earnings automatically reinvest to buy more bonds. I’m a proud affiliate of Worthy. If you sign up under my link, we both get a free bond.
Invest According To Your Risk Tolerance
Knowing your risk tolerance is a vital aspect of risk management. Make sure you take the time to figure this out so you can invest accordingly.
If you’re uncomfortable with the idea of significant fluctuations in the value of your investments, consider a more conservative asset allocation with a higher quantities of less volatile assets like bonds.
Be honest with yourself about how much risk you can handle both financially and emotionally. Avoid taking on more risk than you are comfortable with, because it can lead to impulsive decisions that hurt your holdings.
Align Investments With Your Time Horizon
Low-risk, more liquid investments are better suited for short-term goals where you need are better suited to , while long-term goals may allow for more exposure to higher-risk assets with potential for higher returns.
Understand Investments Before You Get In
Educate yourself about the investments you’re considering. Understand the risks and potential rewards associated with each asset. Avoid investments that you don’t fully comprehend.
Look For Undervalued Assets
Use assets like preferred stocks, close-ended funds, and bonds that have clear valuations. You can use the par values to easily determine when something is undervalued to create a hedge against losses in value.
Close-ended shares have a fixed number of assets which allows you to calculate their NAV price very accurately. From there it’s easy to see when they are priced at a discount.
Use Dollar-Cost Averaging
Instead of buying your entire position in one go, consider using a dollar-cost averaging strategy.
By investing a fixed amount at regular intervals, you can potentially lower the average cost of your investments and reduce the impact of market volatility. This is an excellent risk management tool.
Diversify Your Portfolio
Diversifying your investment portfolio is one of the most effective ways to manage risk. To do this you need to spread your investments across different asset classes, sectors, and geographic regions.
This strategy helps reduce the impact of a single investment’s poor performance on your overall portfolio. Diversification balances out risks and increases the likelihood of achieving more stable returns.
Invest From An Allocation Plan
Establish a tailored asset allocation strategy based on your risk tolerance, financial goals, time horizon, and other criteria.
Allocation strategies create a percentage breakdown for the assets in your portfolio across different asset classes and sectors. A well-balanced asset allocation help you reduce risk and increase returns.
Focus On The Long-Term Picture
Income investing is more about the steady stream of income over time rather than short-term price fluctuations. The value of your account will fluctuate, but that really doesn’t matter when you zoom out.
Look at a 10, 20, or 30-year chart of an individual asset or stock market index. Things trend upwards in the long run despite periods where they pull back. Remember that things cycle through patterns of repetition.
If you can focus on the income generation and keep a long-term perspective, you’ll avoid making impulsive decisions based on short-term market movements.
Invest In Quality Assets
Focus on investing in high-quality income-generating assets.
In the case of stocks, look for companies with strong financials, stable cash flows, and a history of paying dividends. For bonds, consider investing in issuers with solid credit ratings.
Stay Informed
Stay updated on economic trends, market conditions, and developments that may impact your income investments. Being informed allows you to make well-informed decisions and adapt your strategy as needed.
Do Regular Portfolio Reviews
Periodically review your investment portfolio to asses it’s performance and risk profile. Rebalance your portfolio as necessary to maintain the desired asset allocation, especially after significant market movements.
If your financial goals or risk tolerance change, adjust your investments accordingly. There’s no better form of risk management than having an intentional portfolio.
Avoid Emotional Investing
Emotional decision-making leads to poor investment choices. Avoid making impulsive decisions based on fear or greed. Stick to your investment plan and remain disciplined during market fluctuations.
Take Advantage Of Stop-Losses
With a brokerage, you have the ability to use stop-losses to automatically sell at a predetermined price. While the theory sounds all well and good, reality can often cause worse losses during turbulent price moves.
Let’s pretend a news event sends people into a panic. They start to sell off, which triggers stop losses to go off. This pushes the price down further which leads to more panic-induced selling. This happens fast.
Then your stop-loss gets trigged just before savvy investors see that people overreacted and that they can buy the asset at steep discount. They pile in which drives the price back up. You’re left with a big loss and confusion.
The better approach would be to analyze the situation. If the fundamentals are still right, let it ride and make sure the DRIP is on. You could also scoop up more shares at a discount. That would be my play.
I had this happen recently with IEP. It dropped ~35% in a day because of a short seller and fell more over the following week. We were down 50% before the company made an announcement that turned things around.
It rose about 40% from where it fell. But because we allowed dividends to reinvest, our holdings went up 60%. This is why I recommend a longer time horizon verses using stop-losses.
Keep Some Cash Reserves
Aside from your emergency fund, you’re going to want to have some money sitting around for when good opportunities arise. I have a watchlist that I monitor for ones that aren’t within my buying criteria yet.
I like to keep my cash in bullet shares because they’re like having a savings account but in your brokerage. You can sell them at a moments notice to take advantage of other opportunities.
Be Prepared For Changes
Be aware that economic conditions, interest rates, and market sentiment can change — sometimes at the drop of a hat.
It’s important to have a solid foundation to be successful at investing. That includes having plans and strategies ready to implement when the situation calls for it.
Stay flexible and be ready to adjust your income investing strategy as needed to adapt to the ever-evolving market conditions.
Get Advice From More Experienced Investors
If you’re uncertain about managing risk on your own, seek guidance from others. You can talk to other investors like myself or consult with a qualified financial advisor.
Even if you don’t need advice, it’s usually helpful to listen to other investor’s because they may give you ideas or assets you were previously unaware of. Many dividend-paying assets are hard to dig up.
I’m constantly reading other’s newsletters and am part of many subscriptions. Things frequently change in the world of investing. More eyes provide better opportunities than just 2.
To Sum Things Up
No investment is entirely risk-free. Income investing may give you a better hedge because of the payouts generated, but it still involves some level of risk.
By employing the above risk management strategies, you can take a more thoughtful and measured approach to investing. Remember that time horizons are the best perspective and avoid emotional trading.
These tactics will enhance the chances of achieving your income and financial goals while safeguarding your investments against potential downturns.
