Managing Risks
How to manage risks when investing in the market
There’s no such thing as a sure bet with investing, but there are smart ways that you can grow your money — and as a bonus, they’re also often less risky.
While a majority of investors are aware of the risks associated with investing, they may not be comfortable actually experiencing those risks. Two-thirds of investors say they know portfolio fluctuations of 10% are a normal occurrence — but even knowing that, 90% say it’s important to protect their investments when volatility occurs, according to the results of a 2019 survey by Natixis Investment Managers of more than 9,000 individual investors worldwide.
Any time you invest, it’s possible the value of your portfolio will fall — or that your returns turn out to be less than you expected. Having time on your side is one of the best ways to mitigate risks, which is why it’s important to overcome fears and start investing as early as possible.
And while the stock market can experience dramatic moves up or down during short periods of time, historically, the market has always bounced back. That’s one of the reasons why experts recommend you invest money in the stock market for the long term, rather than cash you might need in the next few years.
Here’s how to best manage risks while you’re investing.
1. Only take on the risk you’re comfortable with
As the above survey illustrates, there’s often a mismatch between the level of risk that investors think they’re comfortable with and how much they can actually handle. Your tolerance for investment risk is individual and likely depends on your stage in life and when you need to use this money.
To understand how your appetite for risk aligns with your current (or future) investments, start by taking a risk tolerance assessment, recommends Mike Kojonen, a financial advisor and founder of Principal Preservation Services. This is the first step for Kojonen’s prospective clients — and, once on board, he asks them to take the test again each year.
“We find out what everybody’s risk tolerance is and make sure that their investments are lining up with their risk tolerance,” Kojonen explains. “And every year, we reevaluate because things change.”
Kojonen’s company has one such quiz for prospective clients, though you can also find other risk tolerance assessments for free online through sources like brokerage firms and colleges with financial planning departments. Common topics include:
- When you plan to sell investments
- How long you intend to stay invested
- What you would do with your investments in the event of a major market decline
- How comfortable you are with fluctuations in asset prices
- How you expect your income to change in the future
2. Diversify and use asset allocation to reduce risk
The goal of completing these types of questionnaires is to determine how to invest your portfolio to best align with your risk tolerance, investing objectives, time horizon, and individual financial situation. In turn, your risk tolerance affects your asset allocation, or the amount of your portfolio that’s invested in stocks versus bonds, generally speaking.
Rather than trying to pick winners in the stock market, a proven strategy for success is to invest in the market itself. That’s why so many experts recommend investing in index funds, because they’re a low-cost way to quickly achieve diversification.
When determining your asset allocation, the goal is to have a variety of investments to balance out potential risks of any individual one — what’s known as diversification. In addition to the results of your risk assessment, consider these goals from the Baltimore-based money managers at T. Rowe Price:
- 20s and 30s: 90% to 100% in stocks (because of your long investment timeline), with up to 10% remaining in bonds.
- 40s: 80% to 100% in stocks, with up to 20% remaining in bonds.
- 50s: 60% to 80% in stocks, 20% to 30% in bonds, and up to 10% in cash.
- 60s: 50% to 65% in stocks, 25% to 35% in bonds, and 5% to 15% in cash.
You’ll need to make sure there’s diversification within these asset classes, as well, says Greg Hammer, the CEO and president of Hammer Financial Group. Index funds can easily achieve this, but if you own other types of funds, watch for overlap in the holdings or to make sure your portfolio isn’t skewed to specific industries, he adds.
And if you own individual stocks, such as shares of the company you work for, that also increases your portfolio’s overall risk, Hammer says. “Understand that a single company’s stock is about the highest risk level you can carry.”
Finally, pay attention to your asset allocation as you get older, and rebalance your portfolio as necessary every year or so.
3. Be consistent
By accepting that short-term ups and downs are a given, you can instead focus on the market’s long-term merits. By investing early, you’ll benefit from compound interest, which helps your money to grow at a faster rate because you earn interest on your savings as well as interest on the interest you’ve earned.
It’s also important to create a habit of investing, and to keep adding money to your portfolio at set intervals with an investing strategy that’s known as dollar-cost averaging. This helps to smooth out the amount you pay for an asset, ensuring that you don’t invest all your money when the stock market is at a record high, while allowing you to take advantage of lower prices during periods of when the market gets bumpy.
Adopting a buy-and-hold mindset can also prevent you from making emotional decisions with your portfolio that you may later regret. “If you have time on your side, you don’t need to make any knee-jerk reactions,” Kojonen says.
Finally, you don’t have to have a fancy portfolio to achieve investing success. Rather than trying to beat the major benchmarks like the S&P 500, try investing in index funds, which will help you to keep pace. For example, the long-term historical average annualized return for the S&P 500 is around 10%.
“The more predictable you want to get with your return, the more boring you’ll want to be with your portfolio,” Hammer says.
