Managing Investment Risk

One in three people in the US loses out on putting their money to work in investments because they’re afraid of losing money, according to a recent survey by Magnifi. For them, the risk is simply too high, but what if this belief comes from a misunderstanding of risk entirely?

What if answering the question, "what is risk management?" could help you unlock a whole new level of value in your investing, as well as your life in general? It might be time to look into the many risk management strategies, particularly those associated with investing.

Risk, and the various types of risk, in investing is often seen as something to be avoided, yet we weigh risks every day. Whenever we do anything, such as swimming in the ocean, we conduct our form of risk assessment. We weigh our needs, the potential rewards (the pleasure of swimming), and the potential risks (sharks!) to make a decision.

For some of us, it’s never worth getting into that water. For others, surf’s up. And for others, they’re ready to take some risk, but only after they’ve thoroughly researched shark attacks. This is one example of the risk management process.

Investing is like swimming in the ocean—you have to weigh the potential returns and the various types of risk: Might putting your money into an investment earn you more money? If so, how much cash are you willing to put down on that chance?

There is always a risk you’ll lose your money. But there are ways to manage that risk—and avoid the fear that can hold you back from making sensible, strategic decisions. Managing risk is one of the keys to unlock the tremendous value investing has in store for us. Let's go through some risk examples, as well as some methods to better manage your risk in investing.

All Investments Involve Risk

In investing, risk is defined as the chance that an outcome (or investment’s actual gains) will differ from an expected outcome or return. And yes, risk includes the possibility of losing some or all of an original investment. Risk can be managed and even used to our advantage. Learning to manage risk will give you the confidence to invest in any environment—and yes, even swim with sharks.

Risk Tolerance

First, ask yourself some questions to learn how much risk you can tolerate.

What’s your financial “personality”?

Do you tend to be more conservative with spending your money or more aggressive? Whether you take a personality test or simply track your spending, you’ll be able to assess how you use your cash (and how you feel about it).

How much of your lifestyle depends on the money you want to invest?

If your lifestyle isn’t impacted by what you invest, you might not be worried about a higher-risk investment. Otherwise, you might choose investments with lower risks involved.

How long do you plan to keep your investments in the market?

If you invest after you start your first big job at 25, your investments will have time to recover from losses from higher-risk investments. If you’re 75 and about to retire, you don’t have the luxury of time to wait for your investments to recover from a market drop.

How much do you know about investing?

Investors who have in-depth knowledge of investing can be more comfortable with risk, because they understand its pros and cons. Asking your financial advisor or your AI investing app, or doing the research yourself can build knowledge and confidence.

Risk and Return

When investors put money into a high-risk investment, they expect a higher return. But that’s not guaranteed—going for a riskier investment could mean losing more. That’s why investors talk about “potential”: a lower-risk investment, like bonds, has the potential for lower profit, and a higher risk, like stocks, has the potential for a higher profit (and the potential for a higher loss).

Some investors are willing to accept a smaller, more predictable return in exchange for a more stable investment with less risk. On the other hand, cryptocurrency investors accept potential higher returns for taking on the extra risk.

You don't need to be an expert to invest.

How to Measure Risk

There are a few measures of risk, like volatility, which is how much a stock’s value—or the entire market’s value—fluctuates up and down (like the bumpy turbulence you experience in an airplane). Investors with short-term investments may pay close attention to the day-to-day price swings. For those who are investing long-term, it’s useful to look at historical volatility to help determine the chances of a company’s share value continuing to swing higher or lower.

TIP: A volatile stock that’s been in the news like Tesla (TSLA) has a high % of return as well as a high % of risk. If you want a little less risk with your investments, on Magnifi you can simply search for “investments like TSLA with less risk.”

Asset Risks… and Rewards

Cryptocurrency - This high-risk asset has a high % of volatility. For some, cryptocurrency’s up-and-down swings are too risky; for others, cryptocurrency adds high-return potential to their portfolio.
Equities, or Stocks - Shares in a company can bring high returns, either in appreciation or dividends. However, it’s possible to lose your investment. Stocks aren’t all the same, though: a big, blue-chip stock like Walmart has a lower % of volatility, but also a lower rate of return than an emerging biotech company.
Real Assets - These are tangible things, like gold or buildings, with a high-income potential. They can have some high risk due to losses from changes in global economy or supply and demand. Liquidity risk is something investors should also pay attention to with this asset class. Some assets are more difficult to liquidate than others, which carries its own level of risk. Learn how to invest in real assets.
Bonds and CDs - These investments make fixed payments on the principal investment. These do involve risk, from factors such as changes in interest rates to market valuations—the investor should always read the fine print. Treasury bonds are considered safer, because the US government backs them.
Cash and Cash Equivalents - like Treasury bills. With low risk comes low yield, compared to other investments.

How to Manage Risk

There are ways investors can manage their risk and invest according to their tolerance.

Leverage Your Risk Tolerance

Investors with a larger appetite for risk can satiate this hunger by looking for innovative stocks and industries, which are often accompanied by outsized returns. There’s a catch though — whenever the market hits a rough patch, these assets are often the first to go and fall the hardest.

Similarly, investors that are bullish long-term can use a pullback in prices to start their long-term buying again. The rate at which you buy back into the market is an excellent way to manage your risk. Rather than buying all at once, a risk-averse investor, who is also taking a risk by buying, can ease their way in and reduce their risk by spreading out their buying over a longer period of time.

Diversification

When investors spread their investments across asset classes, they are using a diversification strategy to combine higher-risk assets (for income potential) with lower-risk assets (to help offset that risk). When some assets take a dip, others may go up in value, offsetting the loss.

There is no “one size fits all” template for allocating the different kinds of assets, but traditionally a “middle of the road” portfolio has been made of 40% low risk, like bonds, and 60% high risk, like stocks. Choosing a mutual fund or ETF that focuses broadly on a sector you are interested in also can help diversify, because you’re not putting all your money into one company.

Regularly reviewing your financial goals, risk tolerance, and strategies with your financial advisor or AI investing app is essential to be able to choose the right mix of assets that will help you achieve your goals—and feel confident.

How Magnifi Can Help You Manage Risk

With AI investing, users can help define investment risks, as well as manage them in order to maximize their investment returns. Magnifi can be a pivotal tool in accomplishing the goal of better managing your investment risk. Check out some investments Magnifi found that are considered lower-risk investments below.

You can also search for investments that match your tolerance for risk. Here are a few examples real Magnifi users have found to match their risk tolerance:

See what you can come up with when you sign up for Magnifi today!

References:

“Risk of Death: 18 Things More Likely to Kill You Than Sharks,” Florida Museum, www.floridamuseum.ufl.edu/shark-attacks/odds/compare-risk/death/
"Risk: What It Means in Investing, How to Measure and Manage It," Updated May 25, 2023, investopedia.com, www.investopedia.com/terms/r/risk.asp
"Basic Asset Allocation Models For Your Portfolio," Updated June 12, 2023, forbes.com, https://www.forbes.com/advisor/retirement/asset-allocation-models/#:~:text=Income%2C%20Balanced%20and%20Growth%20Asset%20Allocation%20Models&text=Income%20Portfolio%3A%2070%25%20to%20100,%25%20to%20100%25%20in%20stocks.

Disclosures:

Magnifi is changing the way we shop for investments, with the world’s first semantic search engine for finance that helps users discover, compare and buy investment products such as ETFs, mutual funds and stocks. Open a Magnifi investment account today.

The information and data are as of January 27, 2023 unless otherwise noted and subject to change. This blog is sponsored by Magnifi.

This material is provided for informational purposes only and should not be construed as individualized investment advice or an offer or solicitation to buy or sell securities tailored to your needs. This information covers investment and market activity, industry, or sector trends, or other broad-based economic or market conditions and should not be construed as investment research or advice. Investors are urged to consult with their financial advisors before buying or selling any securities. Although certain information has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness, or fairness. Past performance is no guarantee of future results. This content may not be reproduced or distributed to any person in whole or in part without the prior written consent of Magnifi. As a technology company, Magnifi provides access to tools and will be compensated for providing such access. Magnifi does not provide broker-dealer or custodial services.

Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Use of leveraged commodity-linked derivatives creates an opportunity for increased return but, at the same time, creates the possibility for greater loss.

Neither Asset Allocation nor Diversification guarantee a profit or protect against a loss in a declining market. They are methods used to help manage investment risk.

Mutual Funds and Exchange Traded Funds (ETF’s) are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.