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The old saying “it takes money to make money” is true when it comes to growing your wealth. While Investment can be a very profitable strategy for Wealth Growth, it comes with a lot of intrinsic risks.

 

Most likely you know at least a handful of people who lost money in real estate or the stock market. I was one of these people. I invested in real estate without doing my due diligence and lost… I invested 100% of my 401K funds in the stock of the company I was working for at the time (Morgan Stanley) and was doing great until the market crashed in 2008-2009.

 

I was shocked and really frustrated by my lack of discipline! Since that time I implemented many risk strategies and became very successful with my investment endeavors. I’ve learned my lessons the hard way but you don’t have to. That is why I want to share with you some of the most important Risk Management strategies I know and use.

 

Investment Risk Management strategies

The most important question to ask when considering any investment opportunity is, “How much money can I lose?” Being a successful investor requires patience and caution. Since I am not naturally wired with these faculties, I have to make a conscious effort to pause and ask myself these risk management questions:

  1. How much can I lose if things do not work out as I hope?
  2. How can I minimize the amount of loss?

 

Asking these questions gives me time to contemplate risk management tactics and helps get my emotions out of the way. Once I take care of the potential risk, then I can focus on the fun part—making money!

 

Most people who are new to investing are focused on the potential upside, chasing the latest hot opportunity. They are not inclined to think about what would happen if the best-case scenario doesn’t happen (and it rarely does). Every person has a different risk tolerance, but investors who employ prudent risk management strategies usually enjoy steady wealth growth and experience much less worry and stress.

 

Longer Term Investment Timeline Decreases Risk

Trading does not equate to investing. There are a lot of day-traders—people who trade in-and-out within few days by taking advantage of short-term market fluctuations. Very few short-term or day traders have acquired great wealth.

 

Investing, on the other hand, has a much longer time horizon and most asset classes—stocks, real estate, commodities—appreciate over a longer period of time. This is one more reason to research your investment choices very thoroughly and apply simple risk management approaches.

 

Furthermore, there are times when sitting tight/doing nothing is the best solution—don’t feel pressured to always buy or sell. It’s not the frequency of investing but rather the quality of your decisions over time that adds up to great wealth. Learn when to act and when to wait.

 

Asset Allocation and Diversification As Risk Management

Prudent investing is about reducing risk first. Next it is about managing profits. Nobody can be right all the time, and a disciplined attitude coupled with fundamental risk management are essential. Taking on more risk often leaves you feeling broke instead of wealthy.

 

Asset allocation is an investment strategy that helps balance risk versus reward by adjusting the percentage of each asset in an investment portfolio according to your risk tolerance, goals and investment timeline.

 

Asset allocation is based on the principle that different assets, not perfectly correlated, perform differently in different economic and market conditions. For example, a conservative portfolio may contain the following asset allocation: 40 percent corporate bonds, 10 percent treasury notes, 20 percent cash, 20 percent precious metals, 10 percent stocks. In contrast, aggressive portfolio may have 100 percent of its funds invested in stocks….

 

Diversifying your savings among different asset classes (cash, bonds, precious metals, etc.) decreases your risk of massive losses. Diversification as a risk management tool is extremely important for choosing the actual investment vehicles.

 

NEVER…EVER put all or even most of your money in any one particular investment.

 

If your employer offers you shares of common stock of the company as a form of retirement contribution in addition to your own retirement contributions (a good idea since your contribution is tax free), find out how you can diversify all retirement money among different investment vehicles.

 

Position Sizing Helps Prevent Big Losses

Keeping the discipline of putting no more than 5 percent of your portfolio in one particular position helps avoid significant losses in your asset portfolio. This applies to any asset class.

 

Imagine putting all of your retirement savings into stock issued by the company where you work…and then watching the stock decline due to conditions beyond the company’s control. This imaginary scenario became a reality for a lot of employees during past stock market meltdowns and individual companies’ stocks crashes.

 

Another investment mistake that pertains to position sizing is price leveraging. Let’s say you purchased 500 shares of a company “Z” at $50/share. Then the stock price falls to $30/share and you decide to buy another 500. Your average cost per share of stock now is $40 and you own 1,000 shares.

 

In one week the stock “Z” falls further, to $10/share. You decide to take advantage of yet another bargain and buy 1,000 shares more, so your average cost per share becomes $25. It is highly possible that the stock price will continue sliding and you may end up with a disproportionately high amount of bad investment….

 

I emphasize the importance of having discipline about position sizing and diversification so that you will never end up with disproportionately high amount of bad investments. Greed and emotions are worth enemies when it comes to investment.

I will continue sharing with you about other risk management strategies next week.

 

To Your Health, Wealth and Freedom!

With Love and Gratitude,

millen sig

 

 

Millen Livis

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8 responses to “Investment Risk Management Strategies – Part 1”

  1. It sounds like you’ve experienced what can happen without some foresight and understanding of how to invest, Millen. I think I’ve mentioned that I did lose a lot of money on a property I purchased in Arizona in 2006. Although I had a tenant who almost covered my expenses, when the housing market collapsed in 2008, I couldn’t afford to refinance the mortgage and IndyMac wasn’t willing to “negotiate” because I was a foreign national and it wasn’t my primary home. I’ve lost in many other “too good to be true” investments as well. Now I have an advisor who is brilliant and uses all of the guidelines you suggest above. So far my investments are earning above what one would anticipated and my principal is quite protected. Whenever I am approached now about a fabulous new investment, I politely decline and defer to my advisor. Great tips based on real life experiences. Thanks for your passion for helping us all!

    • Millen Millen says:

      Thank you for sharing your great investment lessons, Beverley. Yes, some lessons are quite expensive but as long as you learn from them – it’s worth it! I can see that you are much more aware of the risks involved in “too-good-to-be true” investments and seems to have a really trusted advisor for your investments. I am sure the wisdom evoked by your investments lessons helped you to find the advisor who you can trust as it is very rare. Thank you for contributing to the conversation!

  2. Sorry you had to learn such a hard lesson Millen, but then I’m a firm believer that sometimes these hard lessons turn out to be turning points in our lives that take us down a better path than the one we were on, and it sounds like that’s what happened with you. Thanks for sharing your knowledge with us. I really like the way you explain investing in a way that anyone can easily understand.

    • Millen Millen says:

      Thank you for your kind words, Marquita. Yes, I agree with your statement: sometimes we need to experience a “contrast” to learn what works. I learned my painful lessons and became quite successful at my investments going forward. After all, what matters is not how many times we fall but whether we can get back up, learn and move on to even better success. Thank you again for your ever insightful comments!

  3. I was never in a position to invest but did let my tax preparer talk me into a 401K. My employer did not match so it was forced savings. Very good advice for me. I knew I would retire with a pension equal to my annual salary, so I didnt worry. My hubby (#2) loves to follow the market & when we dated led me to think he had a lot invested, only to find that his investments matched my 401K. Combined pensions afford us a comfortable life style & he still watches the market as if we had significant investments.

    • Millen Millen says:

      Thank you for sharing, Roslyn! I am really glad to hear that your pension and 401K allow you to have a comfortable retirement. Not many people can retire comfortably these days. Stock investment is not for everybody…. Most people prefer to outsource it to financial advisers. I happened to like investing and, while made a few mistakes, have learned a few things about risk management. And I am passionate about sharing my financial experience with other people. Thank you for contributing to the conversation.

  4. Joyce Hansen says:

    I think a lot of people don’t ask the serious questions when it comes to investing, especially their level of risk tolerance. This is a very helpful article because you point out the importance of diversification, not having all your eggs in one basket and having an independent financial advisor (the most important of all).

    • Millen Millen says:

      Yes, Joyce, I agree! So many people got burned with their investments (whether it’s the stock market or real estate) because they were not considering potential risks. And we all have different risks tolerance, which is one of the main factors in making investing decisions.

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