Managing Your Investment Risk

By Ugochukwu Stanley Nwachukwu

We will be discussing risk as it relates to investing. Risk is a household name in the investment world. You hardly talk about the stock market without mentioning risk. As a result, people have developed erroneous conclusions about risk and risk tolerance in the investing world. Many a time, it is discussed without understanding what it really means.
Topmost on investors' mind when discussing risk is how its knowledge can help to reduce or remove losses from their records. And many others will ask: How can understanding this concept help investors in diversifying their portfolios? I hope you will find this class worth your while.
An often talked about cliche is that of what I'll refer to as 'age-based' risk tolerance. It is conventional wisdom that a younger investor has a long term time horizon in terms of the need for investments and can take more risk. Following this logic, an older individual has a short investment horizon, especially once that individual is retired, and would have low risk tolerance while this may be true in general, there are certainly a number of other considerations that come into play. First we need to consider investment. When will the invested funds be needed?
If the time horizon is relatively short, risk tolerance should shift to be more conservative. For long term investments, there is room for more aggressive investing as time happens to offer more opportunity for capital appreciation even in a less responsive market.
Time is an absorber of risk when it comes to investment as long as you have not made fundamental flaws in your choice of stocks. However, I will always advice that you be careful about blindly following conventional wisdom. For example, it is often said that when you are retired, you must shift everything to conservative investments;Some sophisticated investors have long retired and are still investing in companies that look risky. They have grown to have their own investing principles to follow, which means you also have to develop your own style of investment rather than follow the conventional way of investing in what others term as 'risky or non-risky'.
RISK CAPITAL: By definition, networth is your total assets minus your liabilities. Risk capital is capital that can easily be converted into cash or money available to invest or trade that will not affect your lifestyle if lost, which should be an important consideration when determining risk tolerance. Therefore, an investor with a high networth can assume more risk. The smaller the percentage of your overall networth the investment or trade makes up, the more aggressive the risk tolerance can be because losing it at that point will not be as painful as when you lose what you have based your retirement's survival money on.
Unfortunately, those with little to no networth or with limited risk capital are often drawn to riskier your house stocks' because of the lure of quick, easy and large profits. The problem with this is that when you are trading with your house rent' it is difficult to have your head in the game. Also when too much risk is assumed with too little capital, an investor can be forced to sell his stocks too early even at a loss.
DEFINE YOUR INVESTMENT OBJECTIVES: Your investment objectives must also be considered when calculating how much risk can be assumed. If you are investing for a child's future education or your retirement, how much risk do you really want to take with those funds?
INVESTMENT EXPERIENCE: When it comes to determining your risk tolerance, your level of investing experience must also be considered. It is often said that experience is the best teacher. I think that concept is fully applicable in the investing world though it's better not to experience some things. There are many assumptions one can make if he is not yet in the stock market; or better put, if not an educated investor.
It is prudent to begin new ventures with some degree of caution and investing is no different. Get some experience before committing too much capital. Always remember the old idea behind striving for 'preservation of capital' it only makes sense to take on the appropriate risk for your situation if the worst-case scenario will leave you able to live to invest another day.
There are many things to consider when determining the answer to a seemingly simple question ;What is my risk tolerance? The answer will vary based on your age, experience, networth, risk capital and the actual investment being considered. Knowing your risk tolerance and keeping to investments that fit within it should keep you from financial ruin.
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