You must have heard the famous mantra – “Buy low, sell high!” Is it that straightforward? Of course not! The concept can be tricky. Instead, focus on balancing risk and return for sustainable investment portfolio growth.
However, weighing risks and rewards also looks like throwing darts blindfolded. Making practical, strategic moves is the only way to balance risk and reward. That said, preplan and reevaluate your investment portfolio for a smoother ride.
What is the Risk-Return Trade-off?
This investment principle links high risk with high returns. Risk-return trade-off is a central part of portfolio assessment and each investment decision.
However, a risk-return trade-off varies based on various metrics, including:
- Time horizon
- Risk tolerance
- Investment type
- Years to Retirement
- Market & economic trends
- Potential to replace lost funds
Sources of Investment Risks
Check out the types of risks in investment to avoid red flags early.
- Systematic Risks: From poll results and geo-political tensions to weather, anything that spurs the entire market is a systematic risk.
- Liquidity Risks: If you can’t buy an asset quickly at a fair price, you can lose money or miss opportunities.
- Inflation Risks: A higher inflation rate shrinks a currency’s purchasing power and negatively impacts the value of your investments.
- Credit/Mortgage Risks: An investor falls into trouble if an issuing debt investment company, individual, or government fails to pay the interest or repay the principal at maturity.
- Foreign Investment Risks: The risk of loss when investing in financial instruments in a foreign currency.
Now, let’s understand the key investment approaches to manage risk-reward trade-offs.
A Proper Mix of Investments is a Key
Portfolio diversification plays a critical role in balancing risks and rewards. Also called asset allocation, this strategy involves spreading your investments across different asset classes.
So, your portfolio must include mutual funds, stocks, ETFs, bonds, and cash.
When you invest across many sectors, your investment portfolio doesn’t suffer drastically during the downturn. If one asset category offers poor or average returns, the other will perform well based on the market conditions. Generally speaking, different categories will counteract your losses.
Thus, look beyond one particular asset class and sector.
Risk Assessment
This strategy will help you know your risk tolerance and willingness to take on risk. As an adage goes, “Don’t put all your eggs in one basket.”
A low-risk tolerance means you’ll choose to invest in less volatile assets with lower returns. On the other hand, investors with high-risk tolerance will be keen to invest in higher-risk assets with more potential returns.
So, you must know your financial goals, conditions, and time horizon to assess your risk tolerance. Investors with short-term goals should choose less volatile assets to maintain their capital.
Highly volatile assets are better options for a long-term investment horizon and better rewards. For example, long-term equity investment will allow you to participate in bull markets and recover from the risks of bear markets.
Continuously Monitor the Market
Daily assessment of market trends, growth indicators, and financial metrics can help you find high-reward investment opportunities. Monitoring is also a way to rebalance your portfolio based on constantly changing the market.
This technique allows you to identify undervalued assets or sectors in emerging markets with growth potential. Different investment assets and sectors’ risk and return aspects change with time. Thus, regular tracking lets you align your financial goals and risk tolerance.
Further, ensure timing the market to boost your returns on investment. This means knowing when to enter or exit an investment. Regular technical analysis is fundamental to making the right call. Exiting at the correct time will improve your profit margin and save you from significant loss.
This whole approach is like online gambling. You’ll play real-money games on any casino site only after conducting thorough research about the operator, such as whether Slots and Casino is legit, its game portfolio, Return to Player, market credibility, and payout timelines. Similarly, a gambler will know when to stop gambling to avoid significant losses.
Maintain Emergency Funds
Be a smart investor. What does it mean? You want some amount to stay safe and liquid. So, put enough funds in a savings account or product for unforeseen situations, like layoffs.
The rule of thumb for most investors is to keep six to eight months of their funds in savings. However, the amount you need in emergency funds depends on your personal factors, like the monthly budget, the number of dependents, spouse with a job, or parental support.
Further, consider the cost of common unexpected expenses you’ve had before to set aside a proper value. Start small if your in-hand income doesn’t allow you to save enough cash.
Last but not least, use the emergency funds only for true emergencies.
FAQs
1. What are the Safest Investment Assets?
Government bonds, fixed deposits, treasury securities, and money market mutual funds have the lowest risk. However, the final choice varies based on economic conditions and personal investment goals.
2. What is the Formula for Risk?
The combination of an event’s possibility and consequence is risk. Hence, Risk = Likelihood × Impact.
3. What is the Warren Buffett 70/30 Rule?
It’s an investment portfolio with 70% of the investment in stocks and 30% in fixed-income securities. Usually, it’s moderately risky.
Bottom Line
Everyone invests, hoping to make money over time. However, it depends on how much risk you’re willing to take.
So, gauge the risk-reward margins for investment portfolio stability. Patience, discipline, and long-term goals are the art of acing this game.
