How to Minimize Investment Portfolio Risk
There are times when an investor should consider re-balancing her portfolio to minimize risk. When the stock market is particularly volatile, or when an investor is nearing retirement, it becomes more important to protect assets than to go for risky growth. An investor who has an inherently low tolerance for risk should also consider this option. Here are some ways to minimize investment risk.
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Cut stock weighting. The easiest way to reduce the risk of loss is to move investments from stocks into assets such as bonds or short term cash accounts. Compared to stocks, government, corporate and municipal bonds are safer in preventing serious loss. Bonds amount to interest-bearing IOU's. Cash accounts are the safest of all. Understand that weighting the portfolio toward bonds or cash accounts also generally means a lower rate of return on your investments. From 1926 to 2007, a portfolio of 80 percent stocks and 20 percent bonds yielded an average of 9.7 percent annual growth. A portfolio of 40 percent stock and 60 percent bonds yielded a 7.9 percent return.
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Shift your stock mix. If a particular segment of the market is in a slump, consider moving money out of stocks which are most vulnerable and into stocks with a stronger outlook. The problem, of course, is recognizing which stocks are vulnerable. Smaller companies often feel the pinch sooner and more deeply than larger, well-capitalized companies. Large-cap growth stocks usually weather market slumps better than small-cap growth companies. Look for large, strong companies that have gone through difficult market trends before and have come through successfully. Historical data is helpful here (see the Resources section below for historical stock charts).
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Add a portfolio hedge. You can create a buffer for your portfolio by investing a portion of your assets in hedges such as commodity funds, long-short funds or bear-market funds. These are managed funds run by professional investment houses. Choosing one of these funds takes some sophistication and investigation. Do some independent research before investing in hedge funds. Don't rely only on advice by the managers. While these investments may help you sleep at night, knowing qualified managers are watching out for your, they are really only a bet against your other investments. In other words, they do well only when your other investments are doing poorly. Many advisers say the best time to invest in hedges is right after your other stocks have had a quick and significant growth spurt, but not after the stocks have had a significant decline.
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