What are Investment Risks & How to Manage Them?

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Investment risks are an unavoidable reality, yet understanding them can be the difference between success and setback. 

Did you know that, on average, stocks experience a market correction of 10% or more once every two years? And while over 80% of investors believe that diversification can reduce risks, many are still unsure about the best ways to manage them effectively.

But managing these risks isn’t just about avoiding potential losses, but making informed decisions that allow your portfolio to thrive even in uncertain times. 

What is an Investment Risk?

Investment risk refers to the likelihood of experiencing losses compared to the expected returns from the capital you’ve invested. Different investment options come with varying levels of risk, so understanding your own risk tolerance is important when deciding where to put your money.

The key idea is that everyone has a unique level of comfort with risk, and the same goes for investment risk. If there’s one secret to investing, it’s accepting the risks, as well as the potential rewards that come with it.

Once you understand your own risk tolerance, you can choose investments that align with your comfort level and your financial goals.

When is the Right Time to Start Investing?

The best time to start investing ultimately depends on your personal circumstances. However, one thing to keep in mind is the power of compound interest, which can significantly boost your investment returns over time. The earlier you begin, the greater your potential for growth.

Remember that all investments come with some level of risk. It’s important to carefully weigh the potential rewards against the risks before choosing the asset classes that align with your risk tolerance and long-term financial goals. 

So, assess your comfort with risk and how much capital you can commit before building your investment portfolio.

Types of Investment Risk

There are several hazards associated with investing, and each has a unique effect. 

Here are 3 basic kinds:

1. Market Risk

Market risk is the chance of losing money due to factors that affect the overall financial market. These factors can include fluctuations in interest rates, foreign exchange rates, inflation, political instability, or even global events like the COVID-19 pandemic. 

Such changes can influence the performance of most companies and their stocks.
Hedging against market risk is challenging, as even a diversified portfolio may not fully protect against broad macroeconomic trends.

2. Financial Risk

Financial risk relates to a company’s ability to manage its debt. This type of risk arises when a company struggles to meet its financial obligations, such as interest payments or loan repayments. 

If a company overextends itself financially, it may face bankruptcy or significant losses. To reduce exposure to financial risk, diversifying your portfolio is a smart strategy, as it can spread the risk across different investments and industries.

3. Business Risk

Business risk, on the other hand, refers to the uncertainty associated with a company’s ability to generate sufficient revenue to cover its operating expenses. This type of risk is influenced by several factors, including market competition, customer demand, management effectiveness, and regulatory changes. 

A company facing significant business risk may struggle to maintain profitability, which can adversely affect its stock price and investor returns. Just like with financial risk, investors can manage business risk through diversification, investing in a mix of companies across different industries to cushion against the poor performance of any single entity.

How to Measure an Investment Risk?

Making educated financial decisions requires measuring investment risk, which entails comparing the possibility of possible losses to anticipated profits. As a measure of the volatility of an asset’s returns over time, standard deviation is one of the main instruments for evaluating risk. 

A higher standard deviation indicates that the asset’s price has fluctuated significantly, suggesting more uncertainty and risk. Conversely, a lower standard deviation suggests more consistent performance, which may indicate lower risk.

Another common method is the beta coefficient, which compares the volatility of an asset to that of the broader market. A beta greater than 1 means the investment is more volatile than the market, whereas a beta less than 1 indicates lower volatility. 

Investors may also use Value at Risk (VaR) to quantify the maximum potential loss over a specific period with a given confidence level. VaR helps investors understand the worst-case scenario for their investments under normal market conditions.

How to Manage Investment Risk?

Managing investment risk involves employing strategies that can help reduce potential losses while maintaining opportunities for returns. 

Diversification

Diversification, or distributing assets across a range of asset classes, sectors, and regions, is one of the best tactics. Investors could decrease the effect of a bad-performing asset on their whole portfolio by diversifying because gains in one area may be able to offset losses in another.

Asset Allocation

Another approach is asset allocation, which means dividing investments among different asset categories, such as stocks, bonds, and cash, based on an investor’s risk tolerance, goals, and time horizon. 

This strategy helps balance risk and reward, as different asset classes react differently to market events. For instance, while stocks might offer higher returns, bonds generally provide stability, reducing the overall risk in the portfolio.

Hedging

Hedging is also a valuable technique for managing investment risk. Investors can use financial instruments like options or futures to offset potential losses in other investments. 

While hedging can be complex and may involve additional costs, it can effectively safeguard a portfolio from certain types of risk, such as price fluctuations or interest rate changes.

Periodic Portfolio Reviews

Managing investment risk requires regular portfolio evaluations. Risk tolerance, individual financial objectives, and market circumstances can all fluctuate over time. 

Maintaining a well-managed risk profile over time is facilitated by routinely assessing and rebalancing a portfolio to make sure it stays in line with an investor’s present goals and risk tolerance.

Minimize Investment Risks with Lukrom

Achieving long-term success requires effective risk management. Through portfolio diversification, asset allocation adjustments, hedging techniques, and frequent investment reviews, one can effectively minimize investment risks

But if you’re looking to take your risk management to the next level, consider partnering with Lukrom. Lukrom is reimagining wealth generation by providing exclusive investment opportunities designed specifically for accredited investors. 

Through our carefully crafted solutions, such as the Lukrom iFund, which provides remarkable returns with little risk and no volatility, we go beyond traditional markets to provide stability and diversity. Our Real Estate Equity Offerings provide a strong substitute for the stock market by utilizing ground-up development and multifamily value-added opportunities.

Experience The Lukrom Way and explore investment options that combine safety and potential profit. Lukrom’s products are designed to help you achieve your financial objectives, giving effective returns of 7-9.9%, zero foreclosures, and a 20% tax advantage.

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