The hope an investor has for any investment is that it will bring a reward, but there’s a certain element of chance to handle with caution. While you can’t eliminate it, you can manage investment risk through strategic asset allocation, portfolio diversification, and alternative investment solutions. Let’s explore how each one will help protect your investment portfolio.
Investment decisions fundamentally come down to balancing risk and return in order to achieve your financial goals. Finding a sustainable balance requires structuring your portfolio with your time horizon and goals in mind for effective risk management.
The Financial Industry Regulatory Authority defines investment risk as any uncertainty with respect to your investments that has the potential to negatively impact your financial welfare—in essence, the potential to lose some or all of an investment.
Consider how much you’re willing and able to lose in pursuit of returns. Your personal risk tolerance levels should determine the amount of risk and the potential return you should be pursuing.
Learn how to build a resilient portfolio.
As you consider how to manage investment risk, asset allocation is another opportunity to strategically divide your interests. Different asset classes offer varying levels of risk, return, and forms of investment risk.
Market risk poses the most complex danger to investments throughout the public market. Its impact is systemic, influenced by everything from sociopolitical and economic events to natural disasters.
Idiosyncratic risk poses a more limited influence. Its impact is unique to a specific asset, industry, or class without correlation to larger macroeconomic factors. For example, in the energy sector, there are inherent risks associated with the maintenance of infrastructure and regulatory changes. However, idiosyncratic risk doesn’t eliminate the potential for market risks, such as supply chain disruptions.
Individual investment risk is often measured by standard deviation, which considers the relative volatility of an asset compared to the broader market. This is valuable insight, but past performance doesn’t indicate future results.
Before deciding how to allocate your portfolio, make sure you have a clear understanding of the risks and rewards of each asset class and your investment time frame. This will help you evaluate investment opportunities for alignment with your personal risk tolerance and financial goals.
More than selecting investments of different asset classes, portfolio diversification should include segmentation within each asset class. For example, in real estate, consider investment properties of various types and in different regional markets.
When you successfully optimize your portfolio for the greatest return at a given risk threshold, you reach the efficient frontier. This often involves a higher degree of diversification with non-correlated investments to decrease overall risk and increase returns over time.
Choosing a variety of investments with distinct regions, sectors, and industries can reduce the impact of market volatility and manage risk. Diversification is an essential step toward growth potential and building a strong portfolio protected against loss.
Investors seeking to diversify and manage investment risk should consider including alternative assets in their portfolio. When all of your eggs are in one basket, the impact can be devastating in the face of negative swings.
Non-correlated investments such as precious metals, real estate investment trusts, and other physical assets help hedge against capital loss to avoid the worst-case scenario. Investing in hard money ensures your capital is secured with real estate.
Some of the benefits include:
How do you manage investment risk? The best protection against risk is a multifaceted strategy. Rather than a single tactic, leveraging multiple can provide comprehensive safeguards so your portfolio consistently works toward your investment goals.
Years of tireless effort and dedication have made Socotra Capital the premier private hard money lender with a reputation for delivering reliable returns to investors. Discover investment opportunities that set you up for financial success in our Guide to Building a Resilient Portfolio.