It's amazing how often the concept of risk is completely
overlooked by investors They hear a good story or get a
hot tip and never ask "What could go wrong?” Risk is
often held to be a function of reward. 1he more risk you
take, the bigger your hypothetical reward might be. In
recent times that ratio has not always held, and investors
who purchased bonds and safer stocks have often done bette
than the high risk-takers. Common sense tells us that
things will come back into alignment. If risky stocks
don’t deliver rewards, their prices will drop more, while
the price of so-called safety stocks will rise until
they're overvalued. The result might be a situation where
stocks that are wld ely perceived as Qfe are anything but.
it would not be the first time investors got bamboozled by
a1 inability to value stocks realistically.
With the future murkier than usual, you need ways to ensure
you are managing risk intelligently. Here are some ways to
do that:
overlooked by investors They hear a good story or get a
hot tip and never ask "What could go wrong?” Risk is
often held to be a function of reward. 1he more risk you
take, the bigger your hypothetical reward might be. In
recent times that ratio has not always held, and investors
who purchased bonds and safer stocks have often done bette
than the high risk-takers. Common sense tells us that
things will come back into alignment. If risky stocks
don’t deliver rewards, their prices will drop more, while
the price of so-called safety stocks will rise until
they're overvalued. The result might be a situation where
stocks that are wld ely perceived as Qfe are anything but.
it would not be the first time investors got bamboozled by
a1 inability to value stocks realistically.
With the future murkier than usual, you need ways to ensure
you are managing risk intelligently. Here are some ways to
do that:
1) Always assess expected rewards against risk.
The ideal investment is one with a low degree of risk and
high potential reward. Company share prices tend to follow
eamings, and eamings are less predictable than you might
think. But when a company holds assets that aren’t
reflected in its share price or the market overreacts to
minor bad news, you can attain the much coveted “margin
of safety" reconmended by Ben Graham and other investing
experts.
Don't rely solely on beta to measure risk. The beta is a
measure ofvolatility. The number is widely available on
financial data sites. The higher the beta, the more
volatile the stod<'s share price. High beta stocks are
generally considered riskier. When a high beta stock is
purchased at the bottom of its price range, however, it may
be Qfer than many lower beta stocks. Look at compmy debt,
cash on hand, retum on equity and free cash flow in
addition to beta.
Nevertheless, if wide price swings give you ulcers, you may
prefer low beta stocks.
2) Diversify your stodc holdings
Stock diversification allows you to hold riskier issues
without actually taking on more risk, by buying those
issuesin different sectors. A portfolio with 10 stocks in
energy, consumer staples, consumer discretionary, basic
materials and healthcare is safer than one with two or
three stocks in the Qme industry. The riskier your
flocks, the more you need diversification.
materials and healthcare is safer than one with two or
three stocks in the Qme industry. The riskier your
flocks, the more you need diversification.
3) Diversify across asset classes.
No matter how certain you are that stocks are a good value,
you need other assets to protect you during major drops
Bonds, real estate, and predous metals may perform in
opposition to the market, smoothing out the bumps and
allowing you to avoid the kind of panic that causes
investors to dump all their shares at exactly the wrong
time.
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