Given the volatility and uncertainty that characterizes the global capital markets in the current era, risk management has become a critical skill for any investor who wants to weather the market storms and build real long-term wealth.
In this article, we will review today’s most advanced strategies and tools for managing investment risks, which will allow you to fortify your investment portfolio and deal with the crises and challenges you may encounter down the road.
1. The basis: dispersion of assets
The most important principle in the context of risk management is to spread the investment assets in the portfolio as widely as possible. Diversification among as large a number of assets, issuers, sectors, geographic areas, etc., creates a natural protection against volatility and crises that befall specific assets.
In order to achieve effective diversification, one must examine the exposure to the various risks (market risk, credit risk, currency risk, etc.) and make sure that there is no unjustified overexposure to any of them. As a good rule of thumb, investors should aim for a diversification of at least 8-12 different assets.
2. Waiver of return potential in favor of reducing risk
Sometimes it is worthwhile for an investor to consciously give up part of the return potential of certain investments, in exchange for a significant reduction of risk. For example, instead of investing directly in stocks, you can invest in protective puts or purchase an ETF that tracks the entire index instead of specific stocks.
3. Hedging in derivatives
Using financial derivatives (such as options, futures contracts, etc.) for hedging purposes, allows to neutralize or minimize exposure to market risks in specific assets / portfolios. For example, buying put options on the company’s shares will protect you against sharp declines in the share price.
4. Neutralization of currency risks
One of the most prominent risks for the Israeli investor today is the dollar-shekel exchange rate risk. This risk can be neutralized by a parallel investment in foreign exchange linked assets.
5. Index-linked bonds
The index in Israel increases by about 2-3 percent on average per year. A partial investment in index-linked bonds makes it possible to neutralize part of the inflation risk and preserve the real purchasing power of the invested money.
6. Technological diversity
The diversification of assets also on the timeline is essential to minimize volatility and industry risk. It is advisable to diversify the types of companies and technologies you invest in so that there is representation of both mature and stable industries and innovative growth industries, with an emphasis on dispersion within each group.
7. A well-defined investment policy
Defining a clear investment policy that includes rules of thumb regarding the dispersion and allocation of assets, maximum exposure rates to various risks, decision-making processes, and more, can serve as a compass and prevent critical mistakes resulting from impulsive decisions or based on emotions.
8. Controls and regular reporting
Managing investments and performing regular controls on your investment portfolio is essential to make sure it still meets the rules and limitations defined in the investment policy.
For example, if it has been defined that the percentage of exposure to stocks should not exceed 60% of the portfolio, one should frequently check that this is indeed the case and take corrective actions if necessary.
Also, regular reporting on the performance of the portfolio and its level of risk compared to relevant benchmarks, helps in detecting deviations and unwanted trends and taking quick action to correct them.
9. Cash flow management
Maintaining an adequate liquidity cushion in the investment portfolio, in the form of cash or tradable assets at low risk levels, allows investors to meet their current obligations without selling loss-making assets during times of market downturn.
In addition, a liquidity cushion gives a margin of maneuver to take advantage of opportunities that will appear in the markets for additional attractive purchases of quality assets when their prices fall temporarily.
10. Diversity in investment approaches
Diversification between different and sometimes even opposing investment approaches (Value Investing vs. Momentum Investing for example) can reduce volatility in investors’ portfolios. For example, it is possible to merge within the portfolio shares purchased on the basis of a low profit multiplier (value) together with shares that stand out in their growth (momentum).
11. Investment insurance
There are certain financial products on the market today that provide insurance coverage against sharp declines in the capital markets for a premium, similar to car or apartment insurance. These products are relatively expensive but can be a last line of defense against extreme market disasters.
12. Work with an expert investment advisor
One of the best strategies for reducing risks in the investment portfolio and creating growing financial savings is to use a professional investment advisor.
An expert investment advisor brings with him many years of experience in managing investment portfolios. Unlike an independent investor, a consultant has the experience, the broad vision and the right perspective to observe the state of the markets and specific assets, and correctly gauge the risks and prospects.
In addition to identifying opportunities and actual investment management, a professional advisor will assist you in formulating a clear investment policy that fits your requirements and risk tolerance, in spreading and managing the risks on an ongoing basis, and in having controls on the portfolio to ensure compliance with the established rules.
Even in periods of particularly high uncertainty in the markets, when emotions often tend to prevail over the voices of reason, an experienced and objective advisor will help you keep your cool and make wise long-term investment choices.
In conclusion
Correct implementation of diversified strategies for risk management and minimization is the key to effective protection of investors’ capital in a challenging period of particularly dynamic and unpredictable markets. Combining the strategies and tools we mentioned will allow you to create and manage a durable and high-quality investment portfolio that can weather even the most difficult storms.
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