Author: Tony Fitzpatrick, Managing Director, IIFT
Many investors will remember the sense of alarm and fear at the drop in the stock market at the start of the financial crash and the start of Covid. Investors were concerned for the value of their investments, pensions and future financial security as they watched their portfolios take a hammering. These are very uncomfortable feelings but unfortunately all too familiar examples of what happens when you jump into investing without a solid plan for managing risk. Let’s be real — the potential to grow your wealth through investing is exciting, but the flip side, the risk of losing your hard-earned money, is very real. That’s why investment risk management isn’t just for Wall Street pros. It’s essential for everyday investors.
What Is Investment Risk?
At its core, investment risk is the possibility that your investment’s actual return will differ from what you expected — and yes, that difference can go both ways. While most people focus on losing money, risk also means missing out on higher returns because you played it too safe.
Think of risk like driving a car. Going 100 mph might get you there faster, but one wrong turn and you’re in trouble. Going 30 mph? Safe, but it might take forever. Managing investment risk is about finding your “cruising speed.”
Types of Investment Risks
There isn’t just one kind of risk to watch out for — they come in all shapes and sizes:
- Market Risk: This is the big one. The overall market goes up and down, and so does your portfolio.
- Inflation Risk: Your money might not grow fast enough to keep up with inflation.
- Liquidity Risk: You might not be able to sell an investment quickly without losing value.
- Credit Risk: Especially relevant in bonds — the risk that the issuer won’t pay back.
- Concentration Risk: Just like Jake, putting all your eggs in one basket can backfire.
So, How Do You Manage Risk?
Here are some tried-and-trusted strategies to help you manage investment risk like a pro, even if you’re just starting out.
1. Diversify, Diversify, Diversify
Imagine you own shares in just one company, and suddenly that company is hit by scandal — poof, your investment could tank. But if you’ve spread your money across different sectors, geographies, and asset classes (stocks, bonds, real estate, etc.), a bad day in one doesn’t ruin your whole portfolio. These assets move differently because they are uncorrelated to each other. Building a portfolio of uncorrelated investments can significantly reduce risk.
Real-life case? During the 2008 financial crisis, investors heavily concentrated in bank stocks took huge losses. But those with diversified portfolios recovered faster.
2. Know Your Risk Tolerance
Be honest with yourself. Are you someone who checks your portfolio every hour and panics with every dip? You might want more conservative investments like bonds or dividend-paying stocks. If you’re more of a “set it and forget it” type, you might stomach the ups and downs of growth stocks or real estate.
Pro tip: Search online for a Risk Tolerance Test – you can generally complete these anonymously and get a sense of your risk level.
3. Use Stop-Loss Orders
This is like setting a fire alarm for your portfolio. A stop-loss order automatically sells an investment if it drops to a certain price. It’s not foolproof, but it can help limit losses in a crash.
Setting stop losses when buying stocks is a great habit to get into. You can adjust the stop loss position as your investment progresses to ensure it aligns with your risk tolerance.
4. Rebalance Regularly
Over time, your portfolio can drift from your original plan. Maybe your tech stocks did great and now make up 50% of your portfolio instead of 25%. Rebalancing — selling some of what’s gone up and buying what’s lagging — keeps your risk level in check.
Think of it like trimming a bonsai tree. It needs regular attention to stay healthy.
5. Emergency Fund and Affordability
Before you invest anything, make sure you can afford to invest. Your day to day financial obligations come first. Building an emergency fund to cover unexpected life events such as illness or losing your job is another priority to deal with before considering investing. If you have all that covered the, happy days!!!
Final Thoughts: Don’t Fear Risk — Respect It
Here’s the thing: no investment is completely risk-free. Even that savings account earning 1% has inflation risk. But by understanding the types of risk and using smart strategies, you can invest with more confidence — and sleep better at night.
So, take control of your financial journey. Start managing your investment risks — not avoiding them but understanding and working with them. That’s the key to long-term success.
Tony Fitzpatrick
Institute of Investing and Financial Training
To learn more about Risk Management and Investing visit iift.ie
Baggot Asset Management Limited t/a Baggot Investment Partners is regulated by the Central Bank of Ireland
CRO Number: 565467
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