Risk is an inherent aspect of investing – there’s no way to separate the uncertainty of making investment decisions from their potential to go astray and negatively affect your investment capital. Risk mitigation is about creating strategies that can potentially reduce your exposure to risk.
Investment risk can be loosely defined as the uncertainty that surrounds your investment choices. Typically, greater risk equates to potentially higher returns – investors who commit capital to investments that carry higher levels of risk demand increased rewards. There are many types of risk associated with investing, including:
These factors and others are broadly divided between systematic and unsystematic risk. Systematic risk affects entire market segments or the market as a whole, while the latter affects a specific industry or business.
Investors and financial advisors put risk mitigation strategies in play in an attempt to reduce exposure to these many different risk factors, which can potentially derail investments.
Risk Mitigation Strategies
Renowned economist and investor Benjamin Graham wrote in his acclaimed book The Intelligent Investor that, “Successful investing is about managing risk, not avoiding it.”
Attempting to manage risk is the core of any risk mitigation strategy. The level of risk investors are willing to take on is called their tolerance for risk. While investors cannot completely eliminate their exposure to risk, they can follow certain investment strategies in an effort to mitigate certain risk factors.
Here are a few common risk mitigation and risk management strategies:
- Know your risk tolerance. It may be difficult to fully gauge your appetite for the highest level of risk you are willing to take on until you are faced with the reality of potential losses. Your approach to risk tolerance is largely dedicated by your financial goals, investment horizon – younger investors generally are more risk-tolerant than older investors – and personal circumstances.
- Asset allocation and diversification. Allocating investment capital across a range of financial products and alternative assets that are inversely correlated to each other can provide optimal returns while potentially mitigating concentration and other risk factors. Diversifying investments within varying asset classes, sectors, and geographical regions has the potential to further mitigate your total exposure to risk.
- Conduct due diligence. Systematically analyzing your potential investment decisions can help you better gauge and mitigate the risk those decisions can have on the health of your portfolio.
Putting it all Together
Investing brings risk. Investors who seek understanding and knowledge about which risk factors might pose a threat to their investment capital are better positioned to create risk mitigation strategies that can potentially reduce their exposure to risk while still achieving their financial goals.
Risk mitigation strategies are as common as flies at a picnic. You may find some work extremely well and help manage your exposure to risk, while others aren’t as helpful. Learning more about which risk factors you face and discussing them with a certified financial advisor can help you maximize your portfolio’s potential for growth while attempting to manage your exposure to risk.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
There is no guarantee that the investment objectives of any program will be achieved.
