Investment Risk Management

Investment risk management is all about the risk. If you take too much, unless you get lucky, you could lose most if not all of your money. Be too conservative and your return won't even keep up with inflation.

Settle on an investment plan you can live with, one with just the right amount of risk. That way you won't bail on your plan when the going gets tough.

And the going will get tough. That's going to happen when you invest in a volatile investment like stock. 

The key is following a disciplined investing plan inoculated with investment risk management strategies. They’re not hard to learn. The hard part is not letting your emotions get in the way.

Conservative, Aggressive, or Somewhere In-Between?

You probably already know what type of investor you are.

I like to describe aggressive investors as those who think stock market history is going to repeat. Investing in a diversified portfolio of stocks for 5 plus years has proven historically to be one of the best investment going. Aggressive investors believe that stocks—in the long haul—will continue to outperform other asset classes like bonds.

Conservative investors aren’t as confident. They believe history won’t repeat, and ultimately they’ll be left with huge losses if they’re too stock heavy. So, conservative investors are more apt to want to hold onto what they’ve got via a less risky portfolio.

There are lots of risk tolerance quizzes you can take online too. Based on your response to a series of questions, you’re deemed to have a super-conservative, super-aggressive, or somewhere in-between risk tolerance. I like the one at CalcXML.

Given your time horizon for investment and risk tolerance, an investment plan can now be laid, one suitable for both variables. That way you can be assured of sticking to the plan when the going gets tough.

And the going will get tough. History has shown that the stock market has always been a volatile place to put your money. Managing that risk is paramount to your success.

Investment Risk Management Strategies

The first step in creating your investment plan is to determine what percentage of the plan goes toward risky investments and what portion toward less risky investments. For most investors, stocks make up the risky side, bonds the less risky side.

Riskier investments like stock perform well over time, but they can be very volatile during the short term. With less risky investments like bonds, the volatility is less but so is the rate of return.

Because of your ever decreasing time horizon for investment, your risky to less risky ratio needs to be dynamic. It needs to change, specifically to a more conservative {less risky) mix. That’s true whether you’re super aggressive or super conservative.

Do it gradually over the life of your investment plan. That spreads your risk out even more. Remember, your investment plan should never be riskier next year than it was in the past year. It should either remain the same or move to a slightly less risky ratio.

That’s why I call it a dynamic stock to bond ratio.

Diversification is important too, both on the risky and less risky sides. And because your ratios are constantly in flux, mostly due to the volatility of the stock market, rebalancing and reassessing is necessary.

Investment Risk Management

Besides a dynamic stock to bond ratio, diversification, and rebalancing and reassessing, practice dollar cost averaging too.

Dedicating a fixed percentage of your salary to your retirement plan every pay period is an example of dollar cost averaging. Whenever a large amount of money is invested all at once, there is the chance of a subsequent large market downturn. By investing smaller amounts at fixed intervals, this type of risk is defrayed.

Dollar cost averaging dovetails nicely into my concept of quantified financial goals, where fixed amounts are saved every pay period and invested into a customized investment plan for your goals.

In most cases, dollar cost averaging blows away the strategy of trying to time the market, when money is moved in and out of the stock market in reaction to what your “think” the market will do. Better to stick to a disciplined investment plan imbedded with these four investment risk management strategies.