How to Reduce Investment Risk: 6 Ways to Balance Risk and Reward in Your Portfolio

Successful investment involves knowing how to reduce investment risk while maximizing your investment rewards. Any type of investment has the potential to lose value. This applies not only to investments in stock markets, such as stocks or mutual funds, but also to conservative investments such as certificates of deposit (CDs), which may not earn enough from their interest rate to keep pace with inflation.

Each investor must determine his or her own risk tolerance. Nonetheless, it’s still important to know which types of investment risks you might face, and different methods for reducing that risk over time.

Types of Investment Risk

The following are some common types of risk you, as an investor, may face as you’re trying to grow your wealth:

• Business Risk – Buying stock gives you a piece of ownership in a company, while buying a bond is the equivalent to loaning money to a company. Although the company may grow in value and stay in business, it can also lose money, or even go bankrupt.
• Stock Volatility – Over the short term, a stock’s value is subject to a roller coaster of price fluctuations. These can be influenced by events inside the company, as well as those outside it, such as a downturn in the market as a whole.
• Inflation Risk – Inflation rates can easily cause those “safer” investments, such as a CD, to have less buying power over time despite it actually earning money.
• Interest Rate Risk – If you hold a bond and want to sell it before it matures, it can be worth more or less than its face value. If interest rates rise, newer bonds will pay these rates, but if you want to sell an older bond that pays a lower interest rate, you may lose money.
• Liquidity Risk – This type of risk refers to your ability to sell an investment. Some, like real estate, may take time to sell, while others, like a CD, may have a penalty attached if you sell them before they mature.

How to Reduce Investment Risk

The following tips and tricks let you know how to reduce investment risk in your portfolio:

1. Determine Your Investment Goals

You may have a variety of investment goals and, by identifying them, you’ll have a clearer picture of what you should invest in and how to reduce investment risk. For example, if you know you’ll need money for a vacation in a year, you should choose something low risk so the money is more likely to be there when you need it. Conversely, if you have a long-term financial goal, such as retirement, in mind, you can choose a higher-risk investment since you’ll have time to ride out its highs and lows.

2. Make Sure Your Investment Portfolio Is Sufficiently Liquid

If a financial emergency occurs, you may need cash quickly. A sufficient emergency fund should help you cover emergencies without having to sell any of your investments.

3. Follow a Strategy of Asset Allocation

Asset classes refer to investments such as stocks, bonds, and real estate. By buying different investments within an asset class — strategic asset allocation — you’re reducing your risk of major losses.

4. Diversification Is Key

Diversification refers to dividing your money within a certain asset class into a variety of investments within that class. It’s possibly the most important part of knowing how to reduce investment risk.

5. Employ Dollar Cost Averaging

This investment strategy involves designating a certain dollar amount to buying stocks, bonds, or mutual funds on a regular basis. You’ll be able to buy more shares when prices drop and fewer when they’re high. This disciplined approach keeps you from making emotional investing decisions and, over time, your average cost per share is usually lower than your average price.

6. Monitor Your Portfolio Regularly

Don’t just invest money and then let it sit there year after year. Your individual circumstances can change over time. What was once an effective investment strategy may need adjusting as you grow closer to retirement or another major investment goal. 

Rebalancing your portfolio on a regular basis can help keep you from becoming too conservative, or too aggressive, with your investments. Working with an experienced team of financial advisors, you’ll be able to more closely monitor and adjust your portfolio in order to reduce investment risk. That’s exactly what our team at Tumwater is here for.

Every investment has some degree of risk, but by understanding those risks and taking steps to minimize them, you can find a risk and reward balance that you’re comfortable with and that serves your financial needs. For further investment help, download a free copy of our eBook, “How to Retire with Confidence and Clarity” and join our Retirement Income Academy Course.