Investing involves risks. Sometimes these risks are minimal, as is the casegovernment bonds, but at other times, such as with stocks, options and commodities, the risk can be significant. The more risk the investor is willing to take, the greater the potential for high returns. But big investors know that risk management is more important than making money, and rightly soRisk managementis what leads to profitable investments.
Elkinvestment productinvolves certain risks, while some risks are inherent in any investment. Here are a few to consider.
Business risk
Business riskperhaps the best known and most feared investment risk. It is the risk that something will happen to the company that will cause the investment to lose value. These risks can include a disappointing earnings report, leadership changes, outdated products, or business failures. Because of the large amount of potential risks associated with owning stock in a company, investors know thispredictionsthese risks are virtually impossible.
Purchase oneput optionHedging against a large drop or setting automatic stops are the best ways to hedge against business risks.
Mention risk
Some bonds have a provision that makes the business possibleCall backor early repayment of a bond. They will often exercise this right if they have to pay a higher amountcouponon an existing bond than what they would pay at current interest rates.Although this does not mean a loss of principal, for investors who rely on some faithcoupon annuitythis can mean a significant loss of income for their monthly living costs.
For those who rely on coupon income for their immediate livelihood, invest innot available on callbonds,bond funds, or exchange-traded funds are soliddiversificationstrategy.
Allocation risk
Have you looked at yours?401(k)recently? You've probably heard that you should keep it appropriateasset allocationis critical to managing risk as you get closer to retirement. In addition, federal disclosure rules require 401(k) providers to disclose fees associated with investment products.
The younger you are, the more of your portfolio should be allocated to stocks, and as you get older, bonds will slowly become the dominant investment form. Manage your allocation risk and the costs associated with investing in your retirement account by investing in a low-fee target date fund.Also ask for help from someone you trustFinancial Advisorif you do not have the knowledge or experience to manage your own portfolio.
Political risk
Investors in commodities such as oil understand thispolitical risk. When Iran threatened to block the Strait of Hormuz, investors became concernedthe price of oilwould become more volatile and put their investment at risk. The Haiti conflict and terrorist attacks on oilpipelineshas allowed artificial volatility to seep into oil and other thingscommodity markets. In addition, the problems that have arisen in Southeast Asia regarding land claims, as well as tensions between North and South Korea, have shaken the markets in this region.
Sociopolitical risks are difficult to avoid as most events happen without warning, but hard and fastassumptionslikehagenis the best way to weather sociopolitical storms.
Dividendrisic
Dividend risk is the risk that a company will cut or reduce its dividendyield. This is not just a problem for those who have faithdividendto live on in retirement, but when a company cuts its dividend it often causes the shares to lose value as those who owned the shares for the dividend move to other dividend-paying names. Reduce the effects of dividend risk by maintaining a well-diversified portfolio of several dividend-paying stocks. If the dividend is the only reason you hold the stock, you should sell it as soon as possible after the change is announced.
In short
Investing is not without risk, but some investments can beriskier then others. Every investment strategy involves risks, and managing these risks will help you get the best performance from your money. Don't pursue higher rewards without first assessing the risks. Experienced investors know that it is much easier to lose money than to win it.
