4 Risk Management Lessons for Investors

Every transaction you enter into, no matter how innocent it may seem, carries some level of risk. The level of risk usually corresponds to the level of return you can reasonably expect. This is where the old saying «bet big, win big» comes from.

It would be a mistake to assume that you can ever get to the point where you have completely eliminated risk. Seasoned investors in particular will tell you it’s impossible. Instead, you need to mitigate that risk – that means having a plan in place to take action if things don’t go your way.

Paying attention to a few key lessons now will put you in the strongest possible position when facing this risk later in your career.

Why diversification matters

Lesson number one about risk management is that diversification is not a recommendation, but a requirement. You need to spread your investments across different asset classes so that there is no single point of failure to worry about.

Remember the line we all grew up hearing, “Never put all your eggs in one basket? Whoever coined the phrase was talking about investing, whether they realized it or not.

For example, you would never put all your money in stocks – the market itself is too volatile. You’d also want something a little more stable, like bonds. If you’re getting into real estate, you should never focus exclusively on single-family homes. Would you like to combine things and venture into multi-family or commercial rental properties?

Diversification is also one of the reasons real estate wholesaler appeals to so many people. Here, you cooperate with both the buyer and the seller on the transaction. You get the seller to agree to one price and the buyer to agree to a higher price, keeping the difference as your profit. You are making yourself valuable to two different categories of people and you are distribution of total portfolio risk during.

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Research is king

Another essential step to better risk management is to conduct extensive research and due diligence before entering into any transaction. Undoubtedly, the best decisions are always the most informed decisions.

To continue with the real estate example, you would never agree to buy a house without looking at it first. You’ll want to research the local market to see the quality of the school district and get information about nearby places of interest. You would look into the history of the property to see if there are any issues that could affect its value. You would probably have an inspection done to get the seller to address anything major before agreeing to further discussions.

You would do all of this ahead of time so you know exactly what you are dealing with. Any type of investment you make, even something as seemingly simple as the stock market, needs to be looked at with the same careful lens. This is the only way to make the most informed decision to mitigate risk whenever possible.

The importance of clear risk tolerance levels

A point worth repeating is that there will always be risk in one form or another in investing. Therefore, before creating your portfolio, you need to decide how much of it you will like.

There are certain types of investments that are mostly low risk. A classic example would be a bond. However, bonds also have very slow returns – perhaps too slow for your taste. Other types of investments can generate higher returns much faster, but come with a huge amount of risk.

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Regardless, you need to determine your risk tolerance level before doing anything else. That way, you can take steps to ensure you never cross that line. You can use stop-loss orders, for example, in volatile markets.

Have an emergency fund

Finally, it’s always important to have an emergency fund available for when things don’t go your way.

You should never overextend yourself to the point where virtually any loss equals a total loss. Having an emergency fund means having a pool of money to draw from so that even if you get hit pretty hard, you still have the resources you need to keep going.

This also underscores the importance of a long-term perspective when it comes to risk management, especially when dealing with market fluctuations. History shows that there will be periods when the housing market or the stock market will suffer. These periods may even last much longer than we would like. But over time, things are on the upswing, slowly and surely.

You have to be able to wait out the fluctuationsand only part of that includes the resources needed to do so. You also need the mental agility to withstand whatever life throws at you. Just because a stock goes down on Monday doesn’t mean you should sell immediately. You would probably wait to see if it rebounds on Tuesday or Wednesday. The same logic applies to your entire portfolio, but you’re not talking about hours or days. You are talking about years.

Risk management requires a long-term commitment

Ultimately, risk management is something that needs to be honed over time. There will be times when your investments don’t go as planned, which can have a negative ripple effect that you can feel throughout the rest of your portfolio. But if you go into a situation with a plan to deal with the risk in a logical and prudent way, the reverse will also happen.

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You will be left with the ability to deftly manage risks that will carry you forward for years to come. You will be able to properly protect your portfolio regardless of the type of asset you are talking about. Everything you’re involved in comes together to create something stronger as a collective than any element could be on its own.

You’ll also have a clear path to more stable and sustainable returns – which in itself is the most important benefit of all.

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