Spreading Out Investments For Reducing Risks

Spreading Out Investments For Reducing Risks

Having big positions in a single stock is not always a good idea. Successful investors do put in a mass amount of their money in some stocks. But that’s because they have investigated and have strong faith in their research. For small or average investors, it’s just not a good idea to put all the eggs in the same basket.

Spreading out your investments to reduce risk is a strategy that successful investors apply. As an investor, are you good at spreading out your investments to reduce risk? It’s a key component to being a successful investor.

Successful investors never “go for broke,” as the saying goes. Instead, they try to arrange their portfolios so that they earn some automatically over long periods. You do that by going for the long-term growth that certainly comes to well-established companies when they go in relatively free economies during somewhat prosperous years and decades.

More on Spreading Out Investments

A key benefit of spreading out your total investment in several stocks is that you need not worry if an individual stock takes a big hit – your great portfolio should be able to absorb the shock. Perhaps, you can then make a comeback.  For instance, a dollar cost averaging on the stock if you think it’ll go up in the future.

Even when picking a new stock for your portfolio, if your portfolio consists of a long list of stocks, you’ll have to do less research on individual stocks, since getting beaten on one stock won’t drastically affect your portfolio.

So you might do a stock valuation, check the stock grading/analyst opinion and perform a quick general industry analysis and make the decision to buy the stock right there. This strategy relies on the following assumptions to be effective:

  • You don’t spend too much time observing stocks after using this strategy .
  • If any day, for any reason, you have to sell/exchange all your stocks, you will go ahead and actually place the orders without worrying about the trading costs or other reasons.
  • The trading costs are reasonable compared to your total investment value and that you are NOT engaged in frequent trading(trading costs might outweigh returns)
  • You are diversified in other ways (different sectors, some Adrs, precious metals, ETF etc.) as well.
  • You do not worry about beating an Index e.g. S&P within a certain time frame
  • The market as a whole doesn’t go down. You can still practice dollar cost averaging or use other strategies discussed on this website.

Guide to Spreading Out Investments

Spreading out by sector

Your portfolio strategy should start with a fundamental piece of advice that are often highlighted. Spread your money out across most, if not all of the main economic sectors. The proportions should depend on your objectives and the risk you can accept.

Spreading out is aligned with three-part Successful Investors’ investing philosophy

The 3 successful investors’ approaches automatically limit your involvement, especially in trouble-prone areas like new issues, start-up companies and illiquid investments. Obviously, you also need to stay out of companies when the integrity of insiders seems doubtful. You need to recognize the special risks of investing in fashionable or excessively popular minefields, such as Internet stocks in the late 1990s, or income trusts in the previous decade, or green energy in the current decade.

However, rather than avoiding high-risk areas, many beginning investors feel drawn to them. That’s because trouble-prone areas always manage to give some investors the mistaken impression that they can generate big and easy profits. Unfortunately, the risks are even bigger.

Spreading out means avoiding the heaviest risk possibilities

Many investors take on heavy risk in hopes of quickly reversing the losses they suffered during a market turmoil. It’s a tempting stock market strategy in turbulent situations.

You may have noticed a lot of ads for courses in online, short-term stock trading or foreign-exchange trading. The promoters are aiming their pitch at inexperienced investors who have suffered heavy losses. These investors may get persuaded to follow the example of desperate gamblers who bet their last few dollars on a handful of lottery tickets, or a long shot at the track or the casino.

Particularly, that’s a wasteful example to follow, when so many well-established stocks trade at low multiples of earnings and offer high dividend yields.

See Also: 4 High-Risk Investments That Can Offer Big Returns

Spreading out should not involve buying low-risk, low-return, high-fee structured investments

Financial institutions make these often-complicated investments because they think they can easily sell those to investors.

Structured investments often focus on reducing risk. That’s a huge selling point. However, it costs money, which comes out of investors’ pockets. Structured investments can spend so much money cutting risk that they produce limited returns or even losses after five or even 10 years.

See Also: 5 Low Risk Investments For You

Offsetting Losses

When they are just starting out, many investors believe they can afford to take big risks with their money. After all, if they lose money, they have decades to break even. But they overlook the way that simple arithmetic works against you when you take on too much risk.

  • If you lose 10%, you need an 11% gain to break even.
  • In 20%, you need to make 25% to break even.
  • If 20% doubles to 40%, you need to make 66.6% to take you back to where you started.
  • When losses hit 50%, you need a 100% gain to break even.

An 11% gain is quite common. In fact, the market has gained nearly that much annually, on average, over the past 75 years or so. A 25%  gain is kind of more difficult to achieve. You need an above-average year to make that kind of return.

Gains of 66.6% to 100% or more can take years. Even if you make enough money to recover your losses, that only brings you back to where you started, though. You’ve still lost some purchasing power to inflation. But in addition, you’ve lost the time value of your money. You’ve missed out on the compound profit you would have made on your original stake and your profits if you had invested more conservatively and made modest gains of perhaps 5% to 10% annually.

Of course, even the highest-quality, best-established stocks sink when the general market is falling. The difference is that top-quality stocks tend to recover and eventually go on to new highs. Meanwhile, they generally keep paying dividends.

Risk in investment is inevitable but it can be reduced in various ways and strategies

Other Ways to Reduce Risks

Risk is one of the largest causes of the potential return on an investment. Finding that perfect balance between risk and return is a near impossible task, and often, investors find themselves with a portfolio offering a decent return but putting their hard earned money in too much unnecessary risk.

Diversification is Key

Diversification is absolutely one of the keys to creating a low risk portfolio. By diversifying, you don’t put all of your “eggs in one basket,” so to speak. Instead, you spread your capital across a number of different companies or investments. Investing everything you have into equities, for instance, can pose more risk than investing in a combination of stocks, bonds, real estate and other commodities.

Consider Mutual Funds and EFTs

When first starting to invest, some will claim that they do not have the capital available to diversify properly. They will buy one stock and put their financial future on that one company. This is extremely dangerous and easily avoidable. There are two great options for those who either do not have the money to diversify properly or who really do not have the desire to research and follow so many different companies.

Mutual funds and exchange traded funds or ETF’s are two great options for new investors and experienced investors alike.

Basically, both types of funds are a collection of stocks. Mutual funds are professionally managed, meaning that on a day-to-day basis, the mutual fund manager is actively trading the stocks in the fund.

Exchange traded funds or ETF’s are similar in some looks, but quite different in others. Like mutual funds, ETF’s are a collection of investments, usually stocks. The biggest difference is that ETF’s are not actively managed.

Through Bonds

Bonds are a great way to diversify your overall investment portfolio. Bonds typically pay out a set amount of interest on a specified date. Then, this cash can be put into something else or simply used as income, depending on your situation.

Bonds have typically showed returns that are lower than equities, although in the recent economic downturn, bonds showed a nice return comparatively. Young investors may choose to only own equities, which is fine.

However, as you get a little older, stable investments, such as bonds become more and more important. Bond buyers should diversify as well. It is important to purchase bonds from a wide variety of issuers over a wide array of sectors.

Hedging Your Portfolio

Finally, one way you can reduce your risk is to hedge your portfolio. Hedging is an investment strategy that serves almost as insurance against a negative outcome. It does not avoid the negative outcome, does not completely offset it and sometime does not even work at all.

However, if done correctly, a hedge will reduce your overall risk and can greatly help in protecting your valued portfolio.

See Also: Several Types of Investment Risks

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