When it comes to investing, the best offense is a good defense. Yes, you read that right: Minimizing risk comes before maximizing rewards. After all, you want to have net positive income! So here are some strategies to help you reduce the risk of losses when investing.
Even if you’re brand new to the stock market, you’ve probably been told to diversify your assets. But what does that mean?
Basically, when you diversify your investments, you’re making sure that if a single category of the market — for example, citrus production — has a downturn, your overall portfolio stays safe. So if a major frost hits and limes have a poor season, you’ve still got other investments to fall back on.
You can also diversify within a single asset class. Instead of only investing in Joe Schmoe’s Oranges, you could also invest in other growers as well. That way, if something bad happens — maybe Joe gets caught with his hand in the cookie jar — that single stock’s downturn won’t ruin your finances. A fund that is set up like this is called a diversified fund.
Diversify Types of Assets
When you’re investing, it’s wise to invest in different ways. Rather than solely relying on stocks, it’s good to have a mix of stocks, bonds, and if you’re feeling adventurous, perhaps real estate investments. This is part of a strategy of maintaining non-correlated assets, which is conceptually similar to diversification.
Stop-losses are designed to, well, stop your losses from getting too big. When you buy a stock, your long-term goal is to sell it for a profit. This can’t happen if the stock goes down, however. To counter this, you can put in a stop-loss order, which basically says “if this stock’s price goes too low, I just want to sell it to cut my losses.”
For example, let’s revisit Joe Schmoe. After losing his orange grove, he decided to start up a computer parts company. It looks pretty promising, so you invest in some stock at $10 per share. But you also remember that Joe got in trouble before, and you lost out on most of your investment in his old company. This time, you put in a stop-loss order, so that if his stocks drop below $7, you sell everything you have — preventing another dive from negatively impacting your assets.
A potential downside to these, however, is that normal fluctuations in the market could trigger the stop-loss, leading you to sell stocks that would have bounced right back.