5 Ways to Manage Risk

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No one likes seeing the value of their investment portfolios fall. There are ways to manage risk that can minimize the chance of you losing money, but you have to understand nothing will be certain. There are ways that even the safest investments can fail. The trick is finding your comfort level--that point where you are comfortable with the amount of risk you are taking with your investments, and you have maximized the return on your investment at that level.

Diversify

Have a mix of investments (stocks, bonds, cash) in a variety of markets (technology, financial, growth). While you won’t get the highest returns with a mix of investments, you won’t get the highest losses either. Mutual funds by their very nature have built in diversification. Your money is spread out over a more diversified portfolio of investments than you could probably achieve on your own. A rule of thumb to keep in mind if you are investing for retirement is that your age should also be the percentage of your portfolio in cash or money market accounts. In this way, as you age and need the retirement funds more, they will be there to draw on. However, you also have some of your funds in higher risk investments as a hedge against inflation.

Invest Now

The earlier you begin investing, the longer your money can work for you. That means the returns your initial investments generate will begin to generate their own returns for you. Also, having your money invested for longer periods of time makes it less susceptible for small downturns in the market. Market charts will show that, if you had to try and take your money out of the market within a year of being invested, it is less likely you will make a profit than if you tried to take money out after 15 years. This is because the compounding returns will have cushioned downturns in the market.

Have an Emergency Fund

Make sure you have an emergency fund of 3 to 6 months worth of your expenses. This should be money you keep in a money market account. These accounts are liquid, but they will pay higher interest than a standard checking account. If the account is in a bank, it is also covered by the FDIC insurance protection. Knowing you have 6 months of money to live on even if all of your other income is gone is reassuring. It will allow you to put other income in higher risk investments, such as aggressive growth stock funds.

Dollar-Cost Averaging

Dollar-cost averaging is a simple way to avoid risk by not trying to time the market by trying to figure out when to buy low and sell high. Dollar-cost averaging involves spreading your annual investments out into equal monthly investments. By making equal investments at the same time each month, your money will automatically purchase more shares when the price is lower than when it is high. Over time, your average cost per share will fall, and your value will increase. For instance, in January, you invest $1,000 at $100 a share. You get 10 shares. In February the share price is $125. Your $1,000 gets you eight shares. In March, the share price falls to $75. Now, your $1,000 gets you 13.3 shares. In April, the price is back at $100 per share, and you get 10 shares. After 4 months, you’ve invested $4,000 and have 41.3 shares worth $4,130. That’s a 3.25-percent return in 4 months. Many investment companies will make monthly withdrawals from your checking account if you want so you don’t even have to think about it.

Know Who You’re Dealing With

Check the financial rating of the companies you invest with. Just as you wouldn’t invest with a highly risky investment vehicle, you shouldn’t invest with companies that have a precarious financial foundation. Along the same lines, keep your bank deposit accounts under the $100,000 FDIC insurance limit (temporarily raised to $250,000 under the 2008 economic bailout). This will reduce the risk of losing the cash in your deposit accounts.

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