How To Manage Your Investment Risk

Here’s a typical question a financial advisor will ask to determine an investor’s risk tolerance in order to set up an appropriate strategy.

I respond to fluctuations in my investments in the following manner:

  • I will sell quickly any time my investment loses value.
  • Day-to-day market movements make me uncomfortable and if my investment loses value I am likely to sell it and look for a better alternative.
  • I realize that markets may rise and fall randomly and I will watch my investment for at least a year before making changes.
  • I believe that a long-term investment strategy will maximize potential returns and even if poor market conditions resulted in losses in a given year, I will stay invested.

In my experience, some people are afraid of any loss, while others discover their tolerance for risk is a lot lower than stated, or expected, and day-to-day fluctuations make their stomach churn.

Related: When The Market Goes Down, Do You Buy, Sell or Ignore?

Experiencing an investing loss also often alters a person’s risk tolerance.

Why take risks with your investments?

There’s the possibility that you may lose all or part of your investment in exchange for the possibility of a profit.  Among others, some common investment risks are:

  • With an insured bank investment you face inflation risk (loss of future purchasing power).
  • With stocks/mutual funds/ETFs you face the risk that you might lose money if you sell after the value falls below your purchase price.
  • With real estate and collectibles there is a risk that you may not be able to sell when you want, for the price you want.

Just because you take investment risks doesn’t mean you can’t exert some control over what happens to your money.

Related: Give Your Money Time To Grow

If you know the types of investment risk you might face then you can make choices about those you are willing to take and build a diversified portfolio with quality investments that can offset potential problems.

Assessing Investment risk

Each asset class poses their own particular risks.

  • How do you figure out what the investment risks might be?
  • Which ones are you willing to take?
  • Which are never worth taking?
  • What risks are you comfortable taking at any particular point in time?

A lot depends on your goals and personality.  Your attitude can change over time with age, responsibilities and education.

Age is often an important issue.  Conventional wisdom states that the younger you are, the more investment risk you can afford to take.  But be careful about blindly following this rule of thumb.  There are many variables.

A person who is the primary source of support for a number of people – with young kids and a large mortgage, for example – may want to take less risk than someone who is just responsible for him or herself.

Often an RRSP is a young person’s only investment.  Yes, there are many years before retirement, but what if funds are withdrawn to take advantage of the Homebuyers’ Plan, or Life Long Learning Plan, or even to cover a sudden and prolonged job loss or other emergency?

Similarly, when someone is closer to retirement they might want to move some assets to income producers, but just because you’re 65 doesn’t mean you must shift everything to more conservative investments.

Related: Can You Succeed With An All-GIC Portfolio?

The larger a person’s investment base, the more willing they may be to take on added risk with a portion of their portfolio.  Income and future earnings capacity also have a role.

Many people find that the more clearly they understand how various investments work, the more comfortable they feel.

Risky strategies

Some investors make the mistake of assuming a high level of risk by looking for winners.  By investing in something that’s receiving a lot of media attention they may be buying at the market peak and setting themselves up for future losses.

Fearfully selling in a sudden market downturn locks in losses.

Buying and selling too frequently increases trading costs and reduces your portfolio balance unnecessarily.

We increase our risks when we don’t monitor the performance of our portfolio in order to make appropriate changes, such as selling a loser and using the money for another investment.

Those close to retirement age with meager assets should resist the urge to adopt an inappropriately risky portfolio in order to build up their funds in a short period of time.

Related: How My Retirement Plans Got Derailed – Big Time!

Investing to minimize risk

We often associate risk with losing money, but no investment is without risk.  Investing too conservatively can be just as damaging as investing too aggressively.

You may need to adjust to accepting more risk in order to meet your financial goals.

Look at the big picture.  When you choose new investments, do it with an eye to what you already own.

How does the new investment fit in with regard to your asset allocation and diversification?  If the possible consequences are unacceptable to you, it’s better not to take them.

Most investors are interested in minimizing risk while realizing a satisfactory return.  Smart investing involves risk management.

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  1. Jane Savers @ Solving The Money Puzzle on June 12, 2013 at 4:23 am

    Buy and hold is my strategy for now but when I get 5 years out from retirement I will begin to watch for the best time to sell and move to GIC ladders or other CDIC guaranteed investments.

    I may keep a small stable of dividend paying stocks if they demonstrate a consistent return.

    Retirement is a long way off. I only have about $3,400 in stocks and $3,300 in a mutual fund to worry about.

  2. Gary on June 12, 2013 at 8:00 am

    Great post! We are retired; so in order to preserve our capital we had to take more risk than ” rule of thumb” suggests. We are 85% dividend stocks and the balance in bonds and GIC’s. I try not to look at the markets everyday but I’m weak! 1.8% return on GIC”s just doesn’t cut the mustard so we go to dividend blue chippers for 4 to 5% return and a small chance of a capital gain but that would be a bonus.

  3. Shafi on June 14, 2013 at 9:26 am

    For me, buying into some kind of investment is easier than selling it when it’s time. Selling, for me, is the hardest part of investment.

  4. Anton Ivanov on June 14, 2013 at 9:13 pm

    I think it’s also important for investors to understand that their personal preference for risk should not fully dictate their asset allocation. A person in their 20s who has a preference for low risk will shortchange his retirement if he sticks to low-risk investments, such as bonds or cash.

    You need to find a balance between the risk you are comfortable with and the risk that’s appropriate for your investing time horizon.

  5. Michael Smith on June 15, 2013 at 8:38 am

    I have always been a risk taker. I suppose that is why I got into derivatives trading back in 2006. To viewers reading this, do any of you have experience buying and selling stock options? Back in 2008 (before I got serious about trading) would have been a good time to be long a hundred or so LEAP puts!

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