What to consider when managing investing risk

Putting your money to work in the sharemarket means investing in companies or businesses that might have vastly different prospects for providing a return (or loss) on your investment. When you take on this risk, you’re rewarded with the ability to earn a return through sharing in the company’s profits. Your shareholdings also deliver the potential for future gains if the companies in your portfolio continue to perform well. This is what makes the sharemarket appealing as an investment opportunity.

However, a company could potentially fail to deliver on its goals, which may end up causing its share price to fall. This is why understanding risk management is a crucial step in your journey as an investor.

Shareholders have access to huge amounts of information about their investments, including company reports, news, announcements, and industry analysis. Analysing this information before you make decisions about your investments could help prevent substantial losses.

How tolerant to risk are you?

Defining your personal objectives is a crucial part of risk management. It gives you the ability to understand your risk tolerance, and it’ll inform your behaviours when making decisions about how to invest.

For example, if you’re a younger investor with a timeframe of 30 years to achieve your wealth goals, your approach to risk will be different to an investor who’s older and approaching retirement. Or if your goal is to create a substantial amount of wealth in a shorter period of time, you’ll need to take on a greater level of risk (which increases your potential for loss).

The longer your timeframe is for creating wealth, the more you’ll be able to spread out the level of risk. This won’t rule out your potential for loss, but it can reduce it.

Actively manage your investment portfolio

To manage risk appropriately, you need to be an active participant in the management of your portfolio and have a long-term approach. With a long-term timeframe, you may be able to minimise losses because your ability to withstand market fluctuations will be greater. Being active means dedicating your personal time and effort, but there are significant benefits of being active in your decision-making.

Developing a structure for your approach to the sharemarket can be an effective way to maximise your time when managing your portfolio. This can be as simple as a set of rules or guidelines to help you maintain a process when making decisions about your investments.

Consider some of the following factors to help determine your portfolio structure:

• What stocks or sectors to include in your portfolio?
• What stocks or sectors to avoid adding to the portfolio?
• How many stocks should you hold in your portfolio?
• How much of your money will you allocate to each holding?
• Do you have a minimum holding timeframe for each share?
• How much loss as a percentage are you willing to tolerate before you sell?

Having a portfolio structure is a helpful way to manage your emotional and behavioural response to the constant fluctuations of the sharemarket. It supports your decision-making and directs your behaviour, so you can avoid taking on an excessive level of risk, and minimise your potential for loss.

What to do when things don’t go to plan

Every investor will go through times where they executed their approach correctly, only to have the market respond in a way they didn’t anticipate. If this happens, you have the opportunity to reflect on the choices you made when you invested in the particular company or security. Try to learn from the experience by considering:

• Why you invested in the first place?
• What you could have done differently?
• What information was available that could have changed your mind?
• What can you do next time?

Reflecting on every investment decision can help you reinforce the behaviours you have learnt as an investor. Despite the potential for an unfavourable outcome, having a sound longer-term strategy makes you more equipped to manage risk and minimise potential loss.

The bottom line

Unfortunately for investors, there’s no way to completely eliminate risk from the sharemarket. However, it is possible to minimise the impact of risk on your investments over the long term, and learning those behaviours will allow you to achieve your goals.