When you’re talking about investing, oftentimes there’s an element of risk, and when you add a volatile economy, the risk can increase. Risk management is key when it comes to making decisions in your investment portfolio.
Andy S. Anderson, financial advisor with CUNA Brokerage Services, Inc., said it’s important to understand the risk you’re taking is in real dollars. Because of this, consider looking at risk in real dollar amounts as oppose to a percentage. Also, be aware when you approach the time to start withdrawing from an investment as the potential for portfolio recovery from a down market decreases. Risk control is an important subject for every investor, but especially those who are approaching or already in retirement.
Let’s look at some key factors when it comes to understanding risk control.
Evaluating your risk
One of the first things you’ll want to do ongoing is evaluate your risk management. According to Thecollegeinvestor.com, using these steps can help investors evaluate risk.
1. Identify the risk and know your risk tolerance – When investing, there’s always the potential to lose. Know your comfort level, and again, look at it in real dollars.
2. Identify the asset classes and the level of risk for each
a. Cash – least risky but lowest returns. It also has liquidity and availability.
b. U. S. Bonds – U.S. Government, municipal bonds, and corporate bonds – has the potential for greater return, but a higher risk than cash
c. Hard Assets – property
d. Equities – stocks – higher risk
3. Time – Long-term investments are better for riskier investments, giving time for recovery in the event of a dip in the market. Short-term investments should be limited risks, since there’s less recovery time.
4. Set goals to keep your focus. Make a plan.
5. Create balance in your portfolio – diversification and balance are key
Types of Risk
There are many types of risk. Investor.gov names five main risks that an investor needs to be aware of. Those risks are as follows:
Business Risk: Refers to stocks and bonds; stocks being ownership and bonds, the loaning of money to a company.
Volatility/Market Risk: Fluctuations of stock price.
Inflation Risk: The general upward movement of prices that can reduce purchasing power and reduce any returns on the investment.
Interest Rate Risk: Refers to bonds and the affect the interest rate will have on the rate of return.
Liquidity Risk: Has to do with the ability to buy or sell at a given time and includes products with any penalties for early withdrawal.
Ways to control risk
Once you’ve assessed general risk, there are some things you can do to add risk control even during an uncertain economy. The main thing to remember is to diversify, and for the best possible outcome, you’ll want to diversify by both category and then within each category.
1. Asset Allocation – Divide your portfolio between different asset classes or categories. These classes/categories include stocks, bonds, mutual funds, real estate, and cash. By diversifying among the different asset classes one can reduce risk because it’s unlikely that any volatility in an uncertain economy will affect all categories/assets at once. Anderson said you periodically need to rebalance your asset allocation model. Rebalancing forces the investor to sell what’s high and buy what’s low. Most investors rebalance annually, but if your risk tolerance is more conservative, you may want to rebalance more often.
2. Portfolio Diversification – By the same token, you should also ensure you are diversified within each category. By diversifying you’re also reducing your risk by investing in a number of stocks, bonds, etc., again, because it’s unlikely that any volatility in an uncertain economy will affect all assets/categories at once.
3. Dollar-Cost Averaging – With dollar-cost averaging an investor can pay a fixed dollar amount at set intervals and the number of shares purchased can rise and decline based on the changing cost of shares. By using dollar-cost averaging the investor may reduce the risk caused by volatility in an uncertain market. Time can help to reduce short term fluctuations that come with a volatile economy when the investment is held over a longer period of time.
It’s important to note, dollar-cost averaging does not assure a profit and does not protect against loss in declining marketing. Since dollar-cost averaging involves continued investing regardless of fluctuating securities prices, you should consider the ability to continue purchases over an extended period of time.
4. Products have been developed that are designed to help with risk control. Many of these products have been developed by insurance companies and they allow the investor to have more control of their downside risk. Other products protect the income for the investor. Products can vary between financial institutions. Ask your representative about specific products offered by your institution.
Reevaluate your investments
Anderson said that periodically you want to reevaluate your investments and your investment plan, especially during times of change in market conditions and life changes. For example, you’ll want to review any beneficiaries to keep your intentions clear and the information up to date.
To reevaluate your investments, follow these steps:
1. Identify areas of potential risk
2. Analyze the likelihood of risk based on current conditions
3. Evaluate potential risk
4. Treat risk when necessary but keep in mind that time can be your ally or your worst enemy when it comes to investing
5. Continue to monitor and review
Financial situations can be complex, especially those that involve investing and investments. Anderson said managing your investments and specifically risk, can be time consuming and have a long-term impact to your finances. So why go it alone? It may be helpful to hire a professional, one who understands the market and the ends and outs of investing. With a good and trusted financial advisor, you can take some of the guesswork out of investing and perhaps gain some peace of mind in a volatile market.
Looking for some help? Andy S. Anderson, financial advisor with CUNA Brokerage Services, Inc., can help. Contact Andy at Andy.Anderson@cunamutual.com to schedule an appointment today.
Representatives are registered, securities sold, advisory services offered through CUNA Brokerage Services, Inc. (CBSI), member FINRA/SIPC, a registered broker/dealer and investment advisor, which is not an affiliate of the credit union. CBSI is under contract with the financial institution to make securities available to members. Not NCUA/NCUSIF/FDIC insured, May Lose Value, No Financial Institution Guarantee. Not a deposit of any financial institution.