High valuations. The Russian invasion of Ukraine. Inflation. Interest rates rising. The supply chain. A bear market. A bull market. What do all of these have in common?
They all can be causes of "risk". Risk can mean many things: uncertainty, volatility, or loss, depending on one's perspective. I might address the various types of risk investors face in the future (such as market risk, company/industry risk, currency risk, interest rate risk, etc.). However, there are some universal rules for how to handle risk that I thought might help when you are uncertain. You have 5 basic options/tactics (with examples).
- TRANSFER THE RISK = If you own a particular investment and no longer want the risk that it has, you can transfer that risk to someone else (i.e., sell the holding and let someone else deal with it).
- ASSUME THE RISK = Company X's stock dropped by 20% recently, but you believe the price is too low and buy 100 shares. You have assumed (retained) the risk in order to pursue a potentially greater reward (or incur a potentially greater loss).
- REDUCE THE RISK = Until now, your only investment has been ABC company stock (your employer). You decide to diversify your portfolio with other stocks/bonds/funds, but keep 50% of your original ABC investment. This way, while you still may rely on ABC for your compensation - as well as your health insurance, life insurance, and some wealth creation (through stock options, for example) - your overall portfolio volatility may decrease, just case ABC underperforms since the other investments may not respond to market conditions in the same way ABC does.
- AVOID THE RISK = You are evaluating holdings in a particular industry which has declining profitability due to economic factors. You decide not to purchase any investments in this industry for the time being.
- SHARE THE RISK = Think of your insurance company. If you are involved in a car accident, potential costs from damages are shared between you and the insurance company. The risk isn't shared equally in this case, but it is shared.