There are no guarantees when it comes to investing. Investors often make decisions based on probabilities, such as possible returns relative to risks.
When you’re dealing with hypotheticals, it can be hard to decide where to invest your money. However, there are ways to protect yourself and manage the risks you’re exposed to.
Below are some steps you can take to strike a balance between risk and reward.
1. Identify an acceptable level of risk
Risk is present in any investment. That’s why you can only invest if you’re prepared to accept a certain amount of risk. Here are 2 ways to tell how much risk you can withstand:
- Know and understand your risk profile
This reflects the amount of risk you can tolerate. It’s best to choose investment products whose risk suitability matches or is lower than your risk tolerance.
Your risk profile is a snapshot of what you know now. That’s why it would also help to take the test regularly and check if you are evolving as an investor. As your risk profile changes, so should your portfolio composition.
- Assess your financial situation
Regardless of your risk appetite, you should consider how much money you can stand to potentially lose without heavily damaging your finances.
It’s ideal to invest only your disposable income or money you won’t be needing soon. You must be emotionally and financially ready for all possible results before you invest.
2. Consider your goals
What are you investing for? Whether it’s to buy property or save for the future, your goal will determine how much to aim for and how long you can stay invested.
Put your risk profile, money goal, and time horizon together. Based on these factors, you can adjust your approach to keep risks manageable. Consider the following scenarios:
- If you’re investing for the long term
With a long-term approach, your money has more time to grow. You can afford to take more risks at the start since short-term drops in value won’t affect your investments that much because you have a long investment horizon.
Just make sure to stay within your comfort level and avoid exposing your money to unnecessary risks.
- If you’re investing for the short term
It’s better to stay on the safe side if you plan to cash out of your investments within 3 years. This involves choosing assets with less risk that are less likely to decrease in value.
You should also be able to easily turn your investments into cash when you need to. Keep in mind that you’d likely see smaller potential gains when taking less risk.
What if investments that suit your risk profile do not offer enough returns to help you reach your goal? In this case, you might need to be flexible with either your money goal or your time horizon.
3. Explore ways to diversify your portfolio
You can’t avoid risks, but you can always minimize them. One way to manage financial risk is to spread it across other investment outlets by way of diversification.
There are different ways to diversify your portfolio. The main goal is to invest in different kinds of assets so that even if one performs poorly, your money has other sources of growth.
You can diversify across asset classes, across time horizons, and even across countries especially if your broker can provide you access to overseas investment vehicles.
Don’t be afraid to ask for help or consult a financial expert if you’re still unsure how to manage risks while you invest.
