Risk is usually perceived as something negative, but it is an integral part of investing. In the words of Mark Zuckerberg: “You risk the most, if not at all.” But how to build a balanced portfolio and minimize losses?
Types of investment risks
Before analyzing the methods of investment risk management, it is worth determining what kind of risks are in question. First of all, let’s talk about the risk of losing money, which arises for many reasons:
- Liquidity risk: the inability to sell an asset if there is no demand for it.
- Default risk: bankruptcy or closure of the issuing company of the asset.
- Market, economic or systemic risk: If the entire market collapses, most of the assets in your portfolio will lose some of their value. For example, when Bitcoin falls sharply, the rest of the cryptocurrencies follow.
- Inflation risk: the return on investment must exceed the inflation rate, otherwise the real return will be negative.
- Concentration risk: If one asset accounts for too much of the portfolio, or if different assets are correlated with each other, then a drawdown in one may lead to a drop in the value of others. A good example is the impact of the auto industry on the prices of metals used in car production.
- Regulatory and political risks: for example, a ban on bitcoin in a particular country.
Minimizing investment risks: 4 basic principles
Falling bitcoin rate Ways to minimize investment risks can be divided into basic and technical. The basic ones are available even to beginners who have never studied financial management. However, despite their simplicity, they effectively protect traders from the most common mistakes.
This classic commandment to minimize investment risks will never lose its relevance. However, novice investors often do not understand that diversification does not mean buying different assets from the same group (say, Bitcoin, Ethereum and Binance Coin), but investing in different types of assets. For example, you can balance your portfolio by dividing funds between cryptocurrency, real estate, gold, and stocks.
2) Buy liquid assets:
Successful investors constantly reshuffle their portfolios, increasing the share of some assets at the expense of others. However, building a dynamic portfolio requires that each of the assets can be easily sold or exchanged. For example, a bank deposit is illiquid because it usually cannot be closed without losing interest. But Bitcoin, on the contrary, can be sold at any time at a good rate on almost any site.
3) Invest only your own funds:
Never borrow money to buy an asset, even if you are sure that it will bring huge profits. This applies to both bank loans and loans from friends. There is a certain category of professionals who speculate with borrowed money – these are margin traders. However, if you are not a pro, then never risk more than your net worth.
4) Look for cheap but quality assets:
It is often said that this or that investment object is undervalued or that it is cheap at the moment. It was on such undervalued stocks with good potential that Warren Buffett made his fortune. Follow his lead.