Risk is an inevitable component of investment. To a great extent, risk also determines the returns you anticipate from your portfolio. Though you can choose the degree of risk you would like to take while investing in a fund, it may alter in the future according to market and economic conditions. Apart from the market conditions, as your goals and appetite for risk change, you might want to modify the risk of your portfolio.
While earning returns is the ultimate goal of your investment, you cannot optimize your investments without adjusting your risks as per your requirements.
Hence, we bring you the top 7 strategies to manage your portfolio risk:
1. Develop a Plan for Maximum Potential Loss
2. Focus on smart Asset Allocation
3. Ensure you have a margin of safety
4. Stay away from Portfolio Volatility
5. Prioritize Liquidity
6. Refrain from Emotional Thinking
7. Analyze your timelines
1. Develop a Plan for Maximum Potential Loss
The worst-hit losses are the ones you didn’t see coming. Hence, the most crucial step to avoid such draining losses would be to anticipate them and be prepared for them. Many equity investors cannot gauge the intensity of losses, leaving their portfolios vulnerable to bear markets and plunging economic conditions.
A probable maximum loss plan can be an essential tool for investors looking to manage the risk of their portfolio in extreme loss markets. By taking a comprehensive look at your investments, you can make informed decisions and take calculated risks that align with your long-term investment goals and risk tolerance.
To create a probable maximum loss plan, it’s important to analyze the asset allocation of your portfolio and the valuation of each asset. This will help you to identify any potential risks that could negatively impact your portfolio in a downturn market.
Valuing your portfolio holdings regularly is crucial to comprehending the potential risks associated with each asset and making the necessary adjustments to mitigate those risks. This process helps you gain a deeper understanding of your portfolio, allowing you to make informed investment decisions that align with your financial goals. By taking these steps, you can ensure that your investment decisions are well-informed and based on a comprehensive understanding of your portfolio’s risk exposure.
2. Focus on smart Asset Allocation
Efficient asset allocation ( diversification) is one of the most fundamental ways to manage portfolio risk. While asset allocation talks about the bigger picture and how the risk of one asset offsets or compliments the risk of another asset in your portfolio, the emphasis when investing in assets should be on individual securities. Do your research right or get a professional portfolio analysis if required to find and invest in undervalued assets. Active portfolio allocation should be at the core of your investment discipline.
Even if you are satisfied with the way you have allocated investments between various investment groups and classes, you need to monitor your portfolio regularly and adjust it according to the current goals and conditions. Watch out for large price swings as they are your cue to change your asset allocation.
3. Ensure you have a margin of safety
Not only for the portfolio as a whole, but a margin of safety is also crucial for each investment in your portfolio. What is the margin of safety? Simply put, it is the difference between the intrinsic value of a security and the price you have paid for it—the larger your margin of safety, the lesser the risk you need to assume. A decent margin of safety will give you room to make mistakes, errors, experiments, or manage extreme economic conditions.
Apart from investing in undervalued stocks, or getting huge discounts, creating a margin of doubt would also include buying stocks of good companies with proven track records and strong finances.
4. Stay away from Portfolio Volatility
As a beginner, you may think that portfolio volatility is not a big deal when everything seems balanced. For example, if your portfolio generated a positive return of 50% and a negative return of 50%, the simple average shows you got 0%. But when you analyze it properly, you realize that you have actually lost 25% of your portfolio.
In the long run, high volatility can cause significant damage to your portfolio returns. That’s why it’s important to balance your portfolio volatility. Less volatile portfolios almost always outperform the more volatile ones. So, it’s wise to make sure your portfolio is balanced to reduce risk and achieve better returns.
5. Prioritize Liquidity
While strategizing to minimize risk, you also need to consider the duration risk — implying that over a certain time, a few investments can grow more sensitive to stock market changes. Liquidity is also vital because cash allows you to take advantage of the market cycle.
For instance, if the market is headed to an extreme downturn due to which even valuable stocks are available at discounted rates, you will not be able to invest in them if you don’t have cash with you. Hence, it is always necessary to account for liquidity while building your portfolio risk plan.
6. Refrain from Emotional Thinking
As emotional beings, our feelings can impact the choices we make and the tasks we perform. However, when it comes to investing, emotions have no place in the decision-making process. Investment decisions should be strictly based on numbers and not influenced by hearsay or headlines. It’s important to conduct a comprehensive risk analysis and carefully consider the correlation of the assets in your portfolio before making any major investment decisions. By doing so, you can construct a well-balanced portfolio that aligns with your financial goals and helps you achieve long-term success.
7. Analyze your timelines
Investing is a marathon, not a sprint. Rather than trying to outperform the market in the short term, it’s important to think about long-term profits and align your investing timeline with your financial and personal goals. Rushing to beat the market can result in a significant loss of your portfolio.
At Jama Wealth, we offer a range of financial services to help you achieve your financial goals, including investment advisory services, retirement planning, and portfolio management services. Our experienced team of financial advisors works with you to create a customized investment portfolio tailored to your individual needs and risk tolerance. With our portfolio management services, you can rest assured that your investments are being actively managed to maximize returns and minimize risk.
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