4 ways to protect your investment portfolio and minimise risk
Investing can definitely have it’s ups and downs especially during uncertain times, but there are ways that you can minimise your losses and protect your portfolio. Lets get straight into it.
- Diversification
Imagine you have a portfolio of 50 holdings, all of which were held in the tech industry. In the following 6 months, the tech industry drops 50%. Ultimately, this means your entire portfolio has halved. The way to avoid this is to include a variety of different investments. Lets take the 50 holdings, and split it into 10% in tech, 10% in emerging markets ETF, 10% into a S&P fund, 10% into retail and 10% in government bonds. Ultimately, this will minimise your total losses because you haven’t ‘put all your eggs in one basket’. This is essentially what diversification means. There are way to calculate investment diversification, a popular method is ‘Jensens alpha’, however this is an article for another time.
The main types of investments are equities (also referred to as shares), bonds (known for their lower risk), and funds. Equities are individual shares in a company and are seen as the most risky of the 3. Bonds are known to be relatively low risk and are a type of interest-paying loan issued by government. Funds are essentially a basket of different shares, so by buying one share of a fund, you are simply investing in every single company within that fund.
Since the early 2000’s, the trend has seen bonds rise in value when equities fall. The performance of bonds does rely on the overall state and confidence of the economy, so if equities are falling due to a recession or global crisis, it can not be assumed that bonds will rise. This is a common mistake that the beginner investor tends to make.
2. Choosing the right assets/investments
Asset allocation refers to the proportion of the portfolio that you put into each asset/investment. Asset allocation will depend on your attitude to risk and your personal approach to investing. You should consider the following when considering your strategy to allocating assets
- Your health
- Your age
- Long terms financial goals
- Length of investments
A young adult in their 20’s saving for their first property will have a differing view to asset allocation than a 30 year-old who is investing for their retirement. This is down to the fact that the 30 year-old will be aiming to invest their money long term which gives them the opportunity to hold their investments and potentially recover from any stock market downturns. The 20 year-old is more likely to sell their investments to enable them to purchase a property. Each of the above factors will affect your attitude to risk.
3. Adjust your risk
If you think that you may need your investment money within the next 1–3 years, you fall into the category of a short term investor. There is a real possibility that the market could fall at the exact time which you need your money. The way to combat this and minimise your risk is to reduce your holdings in equities and increase the weight in bonds or even cash.
Cash is known to carry little to no risk but their is also small chance of the cash increasing in value. The risk with cash lies with inflation and interest rates. If interest rates are lower than inflation, your cash is basically losing value. For example if you are holding your cash in a 1% interest bank account, but inflation rises by 4%, your cash has conclusively decreased by 3% in value. Whilst 3% doesn’t sound significant, if you have saving of $/£10,000, you are losing £300 in value. That’s a weekend away, a new laptop or the christmas presents paid for.
Many investors increase their holdings in cash when they expect to need their money for other purchases. The same goes for bonds, however be careful which bonds you chose as some don’t allow withdrawals until maturity date (a time set in the future).
Adjusting your holdings according to your current risk level will drastically minimise future losses.
4. Be confident and don’t panic
Do not panic sell when the market dips, and don’t take out your life savings to panic buy when the market is at a low. Invest confidently and do your research!
I hope you enjoyed this article and use this advice to continue your success.
