Investing involves two things, “risk” and “reward.” Generally, with increased risk comes a greater reward, however, that doesn’t necessarily hold true for every investment. And sometimes increasing your risk doesn’t always result in a higher potential reward either. When you get into investing, it comes down to learning what level of risk you’re comfortable taking and how you can translate that into a large reward. However, this doesn’t mean you will always end up with that reward, but there are always steps you can take to ensure the greatest reward for the risk you’re taking.
Determine your tolerance
Your first step in reducing your investment risk should be to determine your tolerance level for different types of risks. You should start by learning what your net worth and risk capital are. To determine your net worth, you just need to take your assets minus your liabilities. The risk capital is essentially the money you have that could be lost without changing your way of life. Assuming you’re saving up money, your risk capital will always be increasing. A common mistake that new investors make is that they make decisions based on their entire capital rather than off their risk capital. Essentially, you don’t just want to make investments based on your total capital, you want to take into consideration how much you’re spending.
Do your research
The most straightforward way to reduce your risk with an investment is to simply research it enough. You should learn about the history of the investment, the growth of earnings, debt load and more. One you think you have a pretty good idea, compare it with other investment options and other assets in your portfolio. If you’re dealing with stocks, you should also look at the P/E ratio, or “price-to-earnings.” If the company has a higher P/E ratio, it means that there is a higher risk involved with investing in them. Avoiding stocks with high ratios to manage your risks.
By spreading your risk over a variety of products, you are able to reduce your overall risk. This prevents your assets from all being invested into one venture that could tank at any moment. The only difficult part about diversification is that it requires you to do research on each product. It will mean more work on your end to understand each market, but will inevitably reduce your risk significantly. Since you have a smaller portion invested in each product, if one happens to tank, it won’t be a huge liability for you.
Watch your investments
According to the American Association of Individual Investors, you should make sure to evaluate your holdings once every year and see if you need to buy or sell assets. Your investment preferences, age, and how long you have to invest will all determine how your assets should be allocated, so make sure you check up on them regularly.
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