Risk should be a tool you apply in order to meet your financial goals. There are several types of risk and for each there is a way to manage it. Understand risk and you will become a much more confident investor.
- INFLATION RISK — Inflation risk is the most serious danger for a long-term
investor. Inflation steadily erodes the value of your principal, and you don’t even see it happening.
HOW TO MANAGE INFLATION RISK: Choose growth-oriented investments like stocks and mutual funds which have the best chance of outpacing inflation.
- MARKET RISK — Market risk is the risk of losing your money in a market decline. This is the risk that scares too many investors into “safe” investments — just where they’ll be too exposed to inflation risk.
HOW TO MANAGE MARKET RISK: Diversify your investment dollars across
several types of assets and invest regular amounts at regular intervals (this is called dollar cost averaging). Historically, from generation to generation the stock market game is biased in your favor. Fluctuations around this positive bias are sobering but need to be viewed against the long-term centuries old uptrend.
- BUSINESS RISK — Business risk is the risk that a particular company or industry you’ve invested in won’t perform as expected.
HOW TO MANAGE BUSINESS RISK: Diversify your investments. Invest in different companies and in different sectors of the market.
- INTEREST RATE RISK — Interest rate risk is the risk that your investments will decline in value with an increase in interest rates. This kind of risk applies particularly to bonds. When bond yields rise, their prices will decline. And the longer the maturity of the bond, the more vulnerable it is to price changes when interest rates change.
HOW TO MANAGE INTEREST RATE RISK: Diversify your bond investments
among bonds with different maturities.
- LIQUIDITY RISK — How easy is it to turn your investment into cash?
HOW TO MANAGE LIQUIDITY RISK: Use no-load mutual funds, like those used by B & A Sector Watch, for daily liquidity.
- MANAGEMENT RISK — a bad egg in charge at the top of your company. For example, Gerald Cotton and the over $200 million that went missing from his clients Canadian crypto currency account.
HOW TO MANAGE MANAGEMENT RISK — Invest in the tried and true and what you know. Speculate with only your sports wagering and slot machine money that you know in the back of your mind that you are going to lose eventually.
- SOCIO-ECONOMIC RISK — A change in attitudes, a change in sentiment, unemployment, etc.
HOW TO MANAGE SOCIO-ECONOMIC RISK
Use your lifetime of personal experience and keep your ear to the ground. Don’t get married to but SELL your favorite buggy whip company. Use stock indexes and not individual stocks for investments.
- TAX RISK — Mark Twain: “No man nor woman is safe when the Legislature is in session.”
HOW TO MANAGE TAX RISK
Be aware of IRS rules which are always changing. Look for “loopholes” like long-term capital gains, investment zones, and tax strategies to minimize account drawdowns. Trusts, qualified accounts — like IRAs and ROTH IRAs, and creating your own business should always be on your radar.