Risk Reduction Strategies
The best antidote for risk is to make enough money so as to insulate yourself from any type of poverty or financial insecurity. If you are a person of limited means, the only way to do this is to invest for long-term wealth.
But along the way, there are a few basic rules of investing that can help protect your portfolio from investment risks:
- Education: Take the time to learn what you don’t know. Ask lots of questions, and never walk away unclear. If you don’t fully understand, you will probably put off making a decision. The only way to combat risk is to make informed decisions and take action.
- Diversification: Spread out the money you invest among various types of asset classes and holdings. This strategy helps offset temporary losses of some securities because, in a well-diversified portfolio, it is likely that something is performing well.
- Equities: To combat inflation risk, you’ll need to invest in growth-oriented securities. That means stocks, which have historically outperformed every other type of investment. Just how large a portion you should invest in equities is best determined by your investment goals, time horizon, and tolerance for market risk.
- Professional Help: You should seek the help of professionals via two different routes. First, find a good financial advisor you can trust. He or she will help you determine things like how much of your portfolio should be in equities, whether or not you’ll benefit from various tax breaks, how well you’ll emotionally weather stock market downturns, and recommend specific investments.
Second, you may use professional money managers to manage the day-to-day buy and sell decisions. The best way to tap these professionals is by investing in a mutual fund or variable annuity, where professional money managers manage the underlying investments.
- Tax Deferral: This is a bona fide weapon against risks like inflation and living too long. By investing in a tax-deferred vehicle, you avoid paying capital gains taxes each year and that allows your investment to grow faster over time. Of course, you will eventually have to pay taxes when you withdraw the money. You can also benefit from not paying taxes by buying and holding stocks. You only incur capital gains taxes when you sell.
- Stagger Investments and Withdrawals: To protect yourself against poor timing at either the front end or the back end of the investment cycle, put money in or take money out gradually. Regular, gradual investing provides you with the lower cost opportunities of dollar cost averaging. At the other end, staggered redemptions allow you to cash out strategically, starting with investments that are at all-time highs while avoiding those going through temporary price drops, giving them more time to recover.