Investing Logo.png
 

Lesson Headers 8.png


{Listen to the audio of this section}

Now let's getting into determining your investment objectives and mitigating risk.

 

The stock market and risk

When you put your money in the stock market, you are assuming a certain amount of risk that is unavoidable and that is because your investments are uninsured and your returns are not guaranteed.

Basically, investments can lose their value, the stock market can tumble due to economic reasons, political climates can impact the stock market and you might lose money. Risk isn’t just associated with investing in the stock market though. Even conservative investments carry a degree of risk. For instance, your cash in a savings account is at risk from losing it’s value over time due to inflation and your money in a business is at risk of the business not performing well and having to close it’s doors.


Mitigating risk

There are a number of ways to mitigate risk and they are broken down below.

1. Be clear on your why - a.k.a your investment objectives

For each investment you make, it’s important for you to be clear on why you are investing and when you‘ll need your money back. Here are 2 questions to consider as you set your investment objectives.

 
Lesson 8 - Investing objective questions.jpg
 

1. What are you investing for?

Are you investing for retirement? For your kids college education 18 years from now? For passive portfolio income? For a home several years from now? Understanding the "what" can guide you towards the type of investments you put your money into.

2. How much time do you have to invest?

If you’ll need your money within the next 5 years then it makes the most sense to take a conservative approach to investing because you can’t time the market and have less time for your investment to recover and rebound from a loss if for instance a recession were to happen 3 years into your investment time line. 

If on the other hand your objective with a particular investment is to save for retirement 30 years from now, then perhaps you could be a bit more aggressive in the short term, getting more conservative as you approach your objectives timeline, because you have time to ride out any losses.


2. Determine your risk tolerance

Once your objectives are in place, knowing your risk tolerance is just as critical. Greater returns comes with greater risk but can you stomach possible sharp declines in the value of your investment during a bad market?

It’s best to determine what kind of investor you are - be it conservative, aggressive or in between -  so you can avoid the stress and headaches from investing outside of your comfort zone. 

Also when you understand what you can tolerate as an investor and have your objectives in place, you are less likely to be swayed by “hot” stocks or recommendations from people suggesting to get in on an investment “now!”.


So what kind of investor are you?

Here are a few suggestions to help you determine what kind of investor you are:

 
Lesson 8 - type of investor
 


You are a conservative investor

If your main focus is to gain returns but keep your initial investment steady at the same time, you are a conservative investor. You are ok with very slight dips in the stock market especially if you don’t need your money in the short term but if you are only investing for the short term, dips in the stock market could keep you up at night. You don’t like surprises and you tend to avoid taking on big financial risks. As you approach retirement (when it's less than 10 years away), there’s nothing wrong with being a cautious investor.

 

You are an in-between or assertive investor

If you have a good sense of risk and understand that the stock market typically always recovers from short term declines in a matter of time and it won’t keep you up at night then you are an in-between or assertive investor. You are comfortable taking more risk in the market and understand market declines could be a great opportunity to get some good investing deals with the proper research. If you still have a while to go before you retire or need your investment returns (10+ years) you are ok taking on some additional risk.

 

You are an aggressive investor

If you are all about maximizing your earnings in the market and you understand that big earnings comes with big risk, you are an aggressive investor. You are comfortable with large short term market dips. You typically don’t need your money for 20 to 30 years and you are all about growing your portfolio as much as possible. Becoming a conservative investor is several years down the line for you.


3. Leverage asset allocation and diversification

There are two key ways to mitigate / balance out the amount of risk you take on. The first is asset allocation and the second is diversification, both of which should be combined to help you create a solid risk mitigation plan.
 

 
Lesson 8 - Asset allocation diversification.jpg
 

Asset allocation

Asset allocation is basically having a mix of different investments in your portfolio e.g. stocks, bonds, cash, real estate and small business. This way, if one type of investment experiences major losses, the impact to the rest of your portfolio is reduced due to your asset allocation.

 

Diversification

Diversification is all about dividing your investments into different categories. Ever heard the saying "Don’t put all your eggs in one basket"? We’ll thats exactly what diversification is.

For example, if  you are investing in stocks, then by purchasing stocks in different industries like consumer goods, technology, healthcare etc, you are creating a well diversified portfolio and if for instance the consumer goods or technology industries experience declines, you have your investments in other industries to balance out your portfolio.


But how do you know if an investment is risky?

In the next lesson, we’ll be discussing how to do your research in detail, but in general, to determine how risky an investment is you need to look at it’s performance history (sharp dips and spikes are usually an indication) and the current facts about how it is performing now.

 

Clearly defining your objectives and risk tolerance will help you properly set your investing goals.