How to Limit Investment Risk – 10 Ways

There is no shortage of investment options. Unfortunately, they all carry risks. 

Even if you bury your spare loot in your backyard – you will lose money. By the time you dig it up again, taxes will be due and inflation will have eroded its value. So, you can not avoid risk in investing. However, you can minimize it. Here are 10 ways.

Diversify

The old adage “don’t put all your eggs in one basket” holds true in investing. Diversification involves spreading your investments across different asset classes, industries, and geographic regions. This strategy can reduce the impact of a single investment’s poor performance on your overall portfolio and minimize investment risk.

Determine Your Risk Tolerance 

Remember the scene in the Dirty Harry movie when his financial planner is trying to talk to Harry (played by Clint Eastwood) about risk tolerance in investing? Harry pulls a Smith & Wesson 44 magnum on the guy and says, “Aren’t you saying, a man’s got to know his limitations? Well, aren’t you, punk?”

Okay, so that scene never happened. However, Eastwood’s character did say, “a man’s got to know his limitations.” Of course that goes for women as well and it pretty well sums up risk tolerance.

Before entering into any investment, you have to do the research to know what you are getting into. In addition, you have to do a gut check to be sure you can deal with the risks involved.

If the fluctuations in an investment’s value is going to keep you up at night and ruin your health – it is not worth whatever financial gain it might offer.

Research and Learn

Informed decisions are the cornerstone of successful investing. Thoroughly research potential investments, understand the underlying assets, and analyze historical performance. 

A report by the Global Financial Literacy Excellence Center(GFLEC) and the Financial Industry Regulatory Authority (FINRA) emphasized the need for financial knowledge in making good investment decisions.

Avoid Emotional Investing

Emotions can cloud judgment and lead to poor investment decisions. Fear and greed can drive investors to buy at market peaks and sell during downturns. Developing a disciplined investment strategy can help counteract emotional impulses, thus minimizing investment risk.

Use Dollar-Cost Averaging

One time honored approach to disciplined investing is dollar-cost averaging. This strategy involves investing a fixed amount of money at regular intervals, regardless of market conditions. The long-term effect is to reduce market volatility.

Research by Charles Schwab illustrates the benefits of dollar cost averaging. 

Do Not Try to Time the Market

If you look at the Schwab research, you will find that someone who timed the market perfectly would outperform dollar cost averaging. However, as the Schwab report states, “timing the market perfectly is nearly impossible, the best strategy for most of us is not to try to market-time at all. Instead, make a plan and invest as soon as possible.”

As economist John Kenneth Galbraith said, “The function of economic forecasting is to make astrology look respectable.”

Take a Long-Term Perspective

Taking a long-term approach is key to minimizing investment risk.

Historically, markets have shown a tendency to recover from downturns and deliver positive results over extended periods. Someone who knows a thing or two about that is Warren Buffet. The legendary buy and hold guru once said, “The stock market is a device for transferring money from the impatient to the patient.”  

Build an Emergency Fund

If you are in a lather to invest right away, but do not have a financial safety net – your patience may be tested. However, you need to  establish an emergency fund to cover unexpected expenses before investing.

Having an emergency fund prevents having to liquidate an investment to cover any financial surprises you may encounter. Your emergency fund should have enough cash to cover three to six months of living expenses, according to Vanguard.

Review Your Portfolio

Periodically review and rebalance your investment portfolio. As certain assets outperform others, your portfolio’s allocation may shift, increasing exposure to risk. Rebalancing ensures that your asset allocation aligns with your original strategy and risk tolerance. 

Get Professional Advice

Another way to take emotion out of your finances and minimize risk is to work with an accredited financial professional.

A good advisor can help you create a financial plan based on your goals and risk tolerance.

However, before choosing someone to work with, get familiar with the various types of advisors. You should also understand how your advisor is paid. In addition, you should check an advisor’s credentials and licensing. 

In most states you can check on an advisor’s credentials through the secretary of state’s office.

The Securities and Exchange Commission (SEC) offers an action look-up site to see if an advisor has a court or commission order entered against them. 

Remember, each individual’s financial situation is unique, and there is no one-size-fits-all approach. By combining these strategies and customizing them to your circumstances, you can create a well-rounded investment approach that minimizes risk..

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Max Erkiletian

Max K. Erkiletian began writing for newspapers while still in high school. He went on to become an award-winning journalist and co-founder of the print magazine Free Bird. He has written for a wide range of regional and national publications as well as many on-line publications. That has afforded him the opportunity to interview a variety of prominent figures from former Chairman of the Federal Reserve Bank Paul Volker to Blues musicians Muddy Waters and B. B. King. Max lives in Springfield, MO with his wife Karen and their cat – Pudge. He spends as much time as possible with his kids, grandchildren, and great-grandchildren.