What is investment risk management?
Investment risk management means identifying, evaluating, and limiting the risk of losses when you invest.
Investment risk management 101
Know your risk tolerance
The first step in managing investment risk is understanding your risk tolerance. Two factors work together to determine your risk tolerance – your willingness and ability to take risk.
Risk tolerance comes down to your psychological makeup and preferences and your real-world financial situation. If you’re willing to take risk, but can’t recover from market drops, you could run into real challenges.
An advisor can help you determine your risk tolerance and investment personality.
Create an investment plan and stick to it
Your advisor can help you build an investment plan based on your investing goals and your risk tolerance. Once you have a plan you can review it regularly and update it as your life and goals change.
When you encounter market volatility, remembering your goals and your plan to achieve them will help you stick to your plan and avoid making emotional investing decisions.
Focus on the long run
Market volatility is part of normal and healthy market behaviour. Dramatic moves in the market can make you question your investment plan. However, when the market falls, history shows eventually it comes back even stronger.
Keeping a focus on your long-term investment goals can help quiet media noise and help prevent you from making choices that don’t follow your plans.
Asset allocation and diversification
Diversification is a core technique for reducing risk. It means holding a variety of investments to help lower your worry if 1 investment falls in value. It’s also important to choose an asset allocation that makes sense for your financial situation and goals.
Some factors include your age, what kind of returns you need (and when), and how much risk you can handle. Stocks are often seen as offering the most potential for increasing in value, however, they also have more risk. To create a portfolio with stable returns, you may also invest in bonds, which are typically less volatile but offer less potential for returns, or other assets which may offer lower volatility alongside less return.
Your advisor can help you diversify your investment and choose assets that reflect your risk tolerance and help you achieve your goals.
Strategies to help manage volatility and risk
There are several investment strategies you can use to help limit your investment risk.
With dollar-cost averaging, you invest the same amount of money on a regular basis, regardless of the price of the investment.
Over time, investing this way can lower your average cost per unit — compared to what you’d have paid if you'd bought all your units at the same time when they were more expensive than the average.
Avoid following the herd
An example of herd behaviour is when some investors decide to sell based on bad economic news, and others follow. Soon there’s a big market correction as many investors sell their shares. You’re often better off staying invested and waiting for prices to recover. Likewise, when stocks rise, following the herd can motivate investors to buy hyped and possibly overpriced investments.
Take advantage of market ups and downs
This is a strategy for experienced investors. If you understand a company, you can set a target share price. During a down market mood, you may be able to buy that stock while it’s effectively on sale. In a rising market, when the stock price is above your target, you can sell and take profit.
Remove emotion from your investment decisions
Investing can be an emotional experience. After all, you’re putting your hard-earned money into investments to meet your financial goals. Still, it’s important not to let emotions rule your investment strategy.
Remember, even professionals don’t know for sure when prices will go up and down. Although markets dip, they also recover – and you want to be there when they do. That’s why it’s important to develop a solid investment plan and stick to it over the long-term.