Investment Risk Management
Individual investors have their own, distinct attitude to risk. However, the same investment maxim applies to everyone - the higher the potential reward; the greater the risk attached.
A key factor in successful investing is spreading your investments – this is known as diversification. Creating a well-balanced portfolio of equities, bonds, cash and property should help reduce your level of risk.
DiversificationBecause stock markets, bond markets, cash and property generally don't react in the same way at the same time, there should be a degree of protection if your investments are well spread, although this may not always be the case. So if a segment of your portfolio is declining, the rest of your portfolio is hopefully growing. Diversification means you can potentially offset the impact of poor performance (in one area) on your overall portfolio.
Of course understanding risk is not just about the split between the major asset classes - equities, bonds, cash and property – but about geographical and sector split. For instance are your investments strongly biased in one area – for instance China or the US? Have you a large exposure to energy or telecom companies? Are you predominantly invested in larger, mid-size or smaller companies? Are your bond fund selections high-yield and higher risk or lower risk?
Investors are not always aware of the extent of their exposure to one specific sector or geography. This is why it makes sense to have regular reviews – ideally with a financial adviser.
The basic principle of investing centres on risk versus reward. Every individual looks at this equation differently, a 30-year old with many years before retirement might look at higher-risk, capital growth-orientated investments; while a 65-year old with a shorter investment time horizon might focus on lower-risk, income-generating options. Regular reviews should ensure your portfolio continues to reflect the risk you are prepared to take to achieve your investment goals, which will vary with time as your circumstances change.