Methods of Mitigating Investment Risks

In order to get the most out of your investments, you have to employ strategies that mitigate the risk element involved

*In order to get the most out of your investments, you have to employ strategies that mitigate the risk element involved.*

On a football pitch, there are different kinds of players. We have the attackers who are focused on ensuring that they score goals above all odds, the defenders whose jobs are to prevent the opposing team from scoring, and we have the midfielders who typically balance things out.

Of course, if you’re on the bench, you haven’t even started – sorry.

On the investment pitch as well, you take a stance. Do you want to be a striker, making daring moves to ensure you hit your wealth goal; a defender, holding back to ensure that you minimize possible losses, or do you want to play the midfield taking whatever opportunity comes to you.

The first step to ensure that you make the most out of your investment is to determine your risk threshold as well as the goal of the intended investment. For most people investing for the long term, the goal is to get good returns while also managing the risk element that comes with it.

To mitigate the risks involved in investing, here are some of the best tips:

Diversify your portfolio

Much has been said about diversification and it is for good reason. Diversifying your investment portfolio allows you to spread your risks.

The idea behind this is that if you hold assets that behave differently in different market environments and conditions, then certain investments should be more valuable when others lose value, thus netting off adverse effects.

Diversification can take place in various ways, but the commonest approach is to spread your investment across different industries. Diversification is a good strategy to limit your risk, but it only works if the assets you buy are not correlated.

Asset Allocation / Sizing

Another great way to mitigate risk is to have a carefully selected asset allocation strategy in place. This system typically involves how you weigh investments in your portfolio. Since different asset classes offer varying levels of potential return and market risk, the primary idea is to invest little in risky assets.

It is better to lose half of your money if it is N20,000 than if it is N200,000. Playing defense in this case therefore involves limiting your exposure. What you can do is that as an investment becomes riskier, you reduce how much of it you have and shift the funds to risk-free assets for a period of time.

Timing Strategies

A great way the expert investors mitigate their risk is to master the concept of time. Timing strategies allow you predict the market.

However, just like any financial projection, determining the future involves first understanding the past and assessing present economic conditions. Not sure where to get all that info? The behavioral pattern of stocks on the Nigerian stock exchange can be found on the Yochaa App.

The downside of this method is that timing strategies use pre-determined rules. Unfortunately, financial markets cannot offer you promises of consistent rules as the market has been known to evolve.

As such, not only does your timing strategy need to be calculated, it also needs to be flexible. Trends would only offer you a range and those are subject to extraneous factors. For example, if a war breaks out, your numbers are as good as irrelevant.

Hedging

Hedging is simply a more calculated method of diversification. A hedge is defined as any investment that reduces the risk of adverse price movements in an asset.

It is a process of strategically using instruments in the market to offset the risk of potentially adverse price movements. For you to hedge an asset with another, it must eliminate all possible risk in a position or portfolio.

It requires that you take an offsetting position in a related security that is 100% inversely correlated to the risky asset. Investors who hedge use derivatives. More of this would be explained in future articles.

An understanding of these strategies would give investors the tools they need to make the best out of their investments.

Article by Lawretta Egba