As you may know, risk management is one of the most important parts of maintaining a healthy investment portfolio. But what a healthy investment portfolio should look like varies depending on the person who owns it. An ambitious young investor is going to want to build a much more aggressive portfolio than someone who is a short five years from retirement and looking for a secure means to grow their finances.
How, then, should you go about approaching the complex task of risk management? Below is a brief guide to get you started by pointing out some key variables that will affect the sort of risk management strategy you ultimately choose.
Your risk profile
Your risk profile consists primarily of two factors: your age and your bank account. That is, how old you are and how much money you have to invest. Neither of these factors will rule you out straight away from potentially investing, however, they will affect how much risk you can reasonably take on without suffering any serious long term losses.
When it comes to age, the rule of thumb is the older you are, the less risk you should take. If you are nearing retirement, you don’t want to gamble everything you have on a high-risk investment that could potentially bankrupt and leave you with little to nothing to retire on. By the same token, a younger investor just beginning to build for his or her financial future should take on a few high-risk investments in order to maximize his or her returns. When you still have years to go before retirement, it’s not so dangerous to invest in a few high-risk sectors because you have the time to bounce back from any losses and recover your financial position.
Another huge factor determining how much risk you can reasonably withstand is how much you have to invest to begin with. If you are relatively well off and have a lot of starting capital, you can afford to make some high-risk investments and lose money without completely ruining your future financial security. On the other hand, if you are starting out with less or have spent years accumulating enough wealth to be able to begin investing, you do well to play it safe and stick with the lower risk investments since any potential losses would hit you a lot harder than it would someone with plenty of money to spend.
Your investment goals
Another variable that will affect your risk management strategy is your personal goal. If you are hoping to see the largest gains possible, you will have to accept a relatively high amount of risk. However, if you are more looking to secure your money and simply want consistent rates of growth, you should mitigate your risk to as close to zero as possible.
The relative diversity of your holdings will also affect risk management. This is because a sufficiently diversified portfolio is typically much more resilient to market fluctuations than one with just a few holdings spread across a minimal variety of sectors.