Risk Management And The Importance Of A Diversified Investment Portfolio

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Avatar for Peter-Molnar
2 years ago
Topics: Blogging, Blog, Investing

Speculative investing is the act of investing in securities, such as stocks, based on anticipated price movement. And while it is not a good idea to put all of your cash into a single stock, a diversified investment portfolio can provide a strong foundation to ensure a balanced risk management strategy. This is especially true for start-up founders, whose last line of defense is a healthy risk management strategy.

Having a diversified investment portfolio can contribute to your ability to weather a range of different market scenarios, from a weaker economy to a stock market crash. But without a diversified portfolio, a huge amount of risk can accumulate in a single investment.

Risk management is when you face a situation with unknown outcomes, the effort to limit the possibility of negative outcomes is necessary. Diversification is the most basic type of risk management, where the investments are not in the same investment set. Investments are usually divided into three main categories: stocks, bonds, and real estate, but in recent years cryptocurrency has become a popular form of investment. Having a diversified portfolio is the safest approach to minimize risk in relation to investments.

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Why Stay Diversified?

Stock market crashes are frequent occurrences. In fact, there is a new one every few months on average. Irresponsible speculation in any one market can result in catastrophic loss. The 2008 financial crisis is a prime example. If you had invested all of your savings into the stock market, you would have lost everything. A balanced investment portfolio includes a mixture of assets.

Staying diversified can help you avoid large losses in any one market, which could otherwise wipe out your savings. However, diversification alone will not protect you from significant losses. You also need to implement risk management strategies.

One of the most common risk management strategies is diversification over time. This strategy involves dividing your investment portfolio into time-periods, such as a year, to simplify the investment decision making process. After you create these time periods, you divide your investment dollars into individual security holdings. For example, you may divide your money, that you are willing to invest into five different stocks.

The idea behind this strategy is to make the investment decision easier by breaking it down into manageable chunks. This way, you will not have to make as many decisions in a given time period, which may otherwise be overwhelming. You can then choose the best investment for your time period based on your risk tolerance and investment goals.

Diversification Is a Process, Not a Goal

Diversification is a process. It is not a goal or an end state. You must always keep in mind, that you are investing in order to make money, not to hold an investment. This is why it is not recommended to hold all of your money in the stock market.

To be honest, most people do not have the capacity or time to hold many different types of investments. If you do not have the means to hold a wide range of investments, you should at least have some in each category. The more you have, the better.

You might have a general rule, that no more, than 25% of your funds should be in the stock market. If you keep this rule, you will want to split your money in other ways. For example, you might want to have 10% in cash, 20% in bonds, 20% in real estate and 25% in other assets.

You can also use these proportions as a guideline. You don't have to follow them exactly. Consider your personal situation, risk tolerance, and investment goals. Diversification doesn't need to be limited to only three assets classes. You can have in your possession precious metals, such as silver and gold, private equity, cryptocurrency and more.

Asset Optimization

Asset optimization is a type of risk management strategy. This strategy involves buying assets, when their market value is low and selling assets for their market value, when their value is high. There are two types of assets: cash and investments.

Cash is the simplest type of asset and is money, that you have in hand to spend. Investments are assets, that hold value and can increase in value. You should buy investments, that are likely to increase in value, such as stocks in a growing company, bonds from a government, that is running a surplus or real estate in a city, that is poised to boom. Investments are riskier, than cash but can provide higher returns if the asset is a good one.

Optimization is the process of making choices to make the most out of an opportunity. While asset optimization is a risky strategy, because there is no guarantee, that you will be successful, it can be worthwhile to try. If you are able to purchase an asset for a low price and sell it for a higher price, then you have made a profit. This type of profit is not necessarily the same as trading profit.

Trading profit comes from taking advantage of price differences. You buy an asset when its value is low and sell it when its value is high. This can happen instantaneously due to market instability or over a period of time, such as months in the case of a bond. A trading strategy does not need to be complex to be risky. If you are not experienced in the field, it is better to use asset optimization to buy low and sell high, rather than taking risks immediately with your capital.

Identifying Risks

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Before you can implement risk management strategies, you have to be able to identify the different types of risks, that you may face. The three main types of risk are market risk, credit risk, and operational risk.

  • Market risk: Market risk is caused by the unpredictable nature of the market. It is the risk, that the value of your investment will decrease and is influenced by factors such as liquidity, investor confidence, and political events.

  • Credit risk: Credit risk is the risk, that an issuer of debt will fail to payback the loaned money. Issuers may include governments, companies, and individuals.

  • Operational risk: Operational risk is the risk, that an organization will have operational failures, such as accidents, security breaches, and system downtimes.

Diversification reduces the risk of market and operational risk. It also reduces the risk of losses, if the market or an individual business experiences losses. The greater the diversification, the lower the risk. For example, a stock portfolio is made up of many different companies, that are spread out to minimize the risk, in case of a single company fails, the investment still could be profitable.

Thank you for reading!

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Comments

yep..we have to diversify but one should also know to invest only what you are willing to lose and not to expect a huge return from it in no time.

$ 0.00
2 years ago

That's true. With crypto though you can gain a lot in relatively short time, but it is very risky.

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2 years ago

I first learn this here in read.cash that's why whrn I started earning, I also started diversifying my portfolio. Good thing I did.

$ 0.00
2 years ago

Definitely. It is what we have to do. Good job.

$ 0.00
2 years ago

Yayy, thankie hihi

$ 0.00
2 years ago

The key is to invest only what you are willing to lose. It is difficult today to make such movements, especially for newbies. But we have to gradually enter that world.

$ 0.00
2 years ago

That's right. I am only a small fish in the sea, but I am growing slowly, but surely. You see when I started here in late February I had zero balance in my crypto wallet. Today I am holding 4 different coins including BCH of course.

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2 years ago

Wow, you impress me. I barely have only BCH. And the Cats and BPAD tokens. But I sold the BTC when it was $ 10k ahaha

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2 years ago

You can still hold BTC to get into BTC is never late. The chart shows that it is growing in value on a long term.

$ 0.00
2 years ago