10 Ways to Reduce Risk in Your Portfolio
Humans have a complex relationship with money. We almost always want more and never want to lose it. This creates a direct conflict with the laws of risk and reward. Because of that, we are constantly trying to find ways to decrease risk and increase reward. Below are ten ways to reduce risk in your portfolio and why you should consider a few of them.
Diversification. Spread your investments across different asset classes to minimize the impact of volatility in any one investment. Pretty much everything takes a turn at the bottom and no style or asset class is immune to poor years in the markets.
Asset Allocation. Determine the right mix of stocks, bonds, and cash that aligns with your risk tolerance and financial goals.
Regular Rebalance. Adjust your portfolio periodically to maintain your desired asset allocation, ensuring you're not exposed to too much risk in any area.
Assess Risks. Understand the risks associated with each investment and consider factors like market, credit, and liquidity risks before making decisions.
Invest for the Long Term. Avoid making impulsive decisions based on short-term market fluctuations. Focus on your long-term investment strategy. Things can be crazy in the short term. We feel it more if it happens recently. Carl Richards shows this well below.
Consider Hedging Strategies. Use options, futures, or other hedging instruments to protect your portfolio from unpredictable market movements.
Stay Informed. Keep up to date with economic trends, market news, and changes in the regulatory environment that could affect your investments.
Employ Stop-Loss Orders. Set predefined price levels at which you will sell an investment to limit losses in case of a significant market downturn.
Don’t Monitor Your Investments Too Often. It’s a good idea to review your portfolio's performance periodically, but not too often.
Research published in the "Journal of Finance" by Shlomo Benartzi and Richard Thaler on myopic loss aversion shows that investors' tendency to evaluate their portfolios too often can lead to suboptimal asset allocation and lower overall returns. A great book on the topic is Misbehaving by Richard Thaler.
Consult with a Financial Advisor. Seek guidance from a professional to ensure your investment strategy aligns with your risk tolerance and long-term financial objectives.
By implementing these strategies, you can effectively reduce risk in your portfolio and enhance the overall resilience of your investment holdings.