How to Reduce Investment Risk. Investors face many different types of risks. However, there are many things that you can do to lower your risk--regardless of what type of investment you own. This article shows you how.
The main method for reducing investment risk is diversification. By spreading your investments among several asset classes such as stocks, bonds and cash, you effectively reduce your overall investment risk because there is almost always at least one asset class that is doing well. For example, if stocks are down, then interest rates may be up, which means that bonds could be a good investment.
If you do decide to invest in bonds, another way to reduce your risk is to ladder the maturities of your bonds out over time so that you continually have money coming due that can be reinvested at current rates.
If you are a stock investor, then one common way to diversify your investments is with mutual funds. Diversifying among different types of funds and stocks is helpful as well. For example, if you invest in four different sector funds such as technology, health care, utilities and financials, then your overall equity risk will be reduced because at least one of these sectors is usually performing well.
Another way to lower your investment risk is by using derivatives such as options and futures. Derivatives allow you to hedge your investments and increase your overall return with limited risk and can protect your portfolio from possible downside exposure.
One of the easiest ways to lower your equity investment risk is to simply give them time to grow. Long-term investors are much more likely to see their investments grow over time than market timers or those who invest for five years or less.