Published on April 28th, 2017 by Kostas Chiotis
This guest contribution is by Kostas Chiotis. Kostas is an economist who loves sharing his expertise on various blogs and online publications. Find more details about him on his social media profiles at Facebook and Twitter and his blog FinanceBlogZone.com.
Investing in stocks is one of the best ways to grow your money and secure a strong financial future. But it also comes with the risk that you could lose your money. But there are ways to manage your investments in a way that lowers that risk as much as possible while maintaining as much growth as possible. Here are a few hacks for making sure you are investing right!
#1 Know Your Risk Profile
Every single investor has their own unique risk profile. This is a profile that measures about how much risk you can stand to take with your investments. There are a few different factors that go into measuring how high or low your tolerance is.
The main factors include:
- Age: the closer you are to retirement, the lower your tolerance for risk because you have less time to recover from a loss. If you’ve still got decades ahead of you, you can stand to take a chance on a high risk, high reward stock. If it fails, you have time to pick yourself back up.
- Capital: the more money you have to invest, the higher your tolerance is. That’s because a loss won’t knock you out of the game entirely. It will just set you back. On the other hand, if you’re investing money that it took you years to save up, you don’t want to take a lot of risk with it because it will take years before you can save that amount up again.
- Investment goals: if you’re investing because you want to win big, you have a higher tolerance for risk. You need to because you have to accept the higher risk that comes with higher potential growth. But if you’re investing to save for retirement or develop a steady, reliable passive income, you don’t want to risk your future livelihood.
- Personal psychology: this is an often overlooked factor but it is important. Investing in stocks takes a certain degree of psychological strength. If you want to see overall growth, you are going to have to endure some nerve-wracking periods of loss. Every stock is going to experience ups and downs. It can be a tough game. And if you’re not up to the constant anxiety and doubt, you need to stick with lower risk stocks.
Knowing what your risk tolerance profile is will help you make the right investment choices for you. Sure, that 25 year old who inherited millions from his parents is making a lot of money on high risk stocks. But he’s also losing money in amounts that don’t bother him but could be a death sentence for you. So you need to develop an investment strategy that fits your circumstances.
#2 Don’t Put all Your Eggs in One Basket
If you’re looking for that one stock that will provide you a guaranteed return at no risk, you’re not going to find it. The fact is that stocks just naturally fluctuate. Sometimes they rise. Sometimes they fall. And while some falls are a sign that it’s time to jump ship, other falls are just natural changes in the market.
The best way to protect yourself from any kind of drop in stock value is to make sure that you don’t put all your money in one stock. You don’t even want to put all your money in one kind of stock. Even if you think the tech sector is a promising one that is sure to see a lot of growth, you still don’t want to put all of your money in tech.
Keep a diverse portfolio and you can be sure that the drop in value on one stock will be compensated by the rise in value of another stock. And in this way, you can make sure that no matter what any individual stock is doing, your overall portfolio continues on a steady trend of growth.
#3 Get Out of Debt
This might sound unrelated but it’s essential. Think about the rate of return on your investment portfolio. And now compare it to the rate at which your debt is growing. Chances are, your debt is essentially eating up all or most of the money your investments are generating.
So if you aren’t working toward becoming completely debt free, the fact is that you are losing money—no matter how smart and safe your investments are!
You need to be paying more than the minimum on every single loan, mortgage, credit card, and whatever other debt you have. You need to get rid of all of it as fast as you can so that you can actually enjoy the benefits of every single percentage of profit you’re earning on your stocks.
#4 Look for High Dividends
There are some stocks that pay you dividends. These are usually more established stocks from bigger companies. They know that they’ve grown to a point where their rate of growth isn’t going to be as attractive as a younger stock that has the ability to grow exponentially. So these established companies attract new investors by offering to pay dividends, usually once per year they pay out a certain percentage of what their stock is worth to its investors.
That means that for each dividend-yielding stock in your portfolio, you are getting cold, hard cash in your bank account. You can choose to immediately reinvest those dividends or use them as passive income.
A collection of strong, low risk dividend-yielding stocks is a great foundation to build your portfolio on but, for most people, it’s not the only thing you want. You will want some younger (higher risk) stocks that can potentially add some dramatic upward momentum to your portfolio.
And you also don’t want to just invest in every stock that promises dividends. Promises are still just promises. So you want to look for a stock that has consistently delivered on that promise and also consistently increases its dividends. When investing in dividend stocks, there are a few best practices you’ll want to make sure you stick with.
What low risk investing really comes down to is looking for as many ways as you can to dilute that risk. Every stock carries a certain degree of risk. But the chance that every stock is going to fail all at the same time is pretty low so by spreading your money across different stocks, you dilute your risk. The same is true of investing in dividend stocks. The money you earn in dividends each year helps to offset any loss in value that year.
These hacks and the others you saw above are all part of the larger strategy of dealing with risk rationally. Understand the risk that you are taking on and then figure out ways to dilute and offset that risk. With the right strategy, you’ll be swimming in safe waters and earning money at the same time!