There are few things that grab your attention more in life than losing your hard earned money in the stock market.
Investing in the stock market can provide real rewards for the knowledgeable investor. However, the inexperienced investor who does not understand the risks, and the need to manage these risks, will learn a very expensive lesson indeed.
So how do you diversify your risk in the stock market? It takes an understanding of your objectives. It takes an understanding of yourself and how you react to the daily fluctuation of stock prices. It takes patience. It takes the knowledge to invest across different financial products. It takes a plan and the plan requires adjustment and follow up.
Based on my experience, here are my ten tips for success in the stock market through risk management and financial product diversification:
Tip 1: Have An Emergency Fund: You should have the equivalent of six months cash in reserve to meet your monthly expenses in case of household emergencies. The risk of household emergencies or job loss can impact your investment performance by requiring you to redeem your investment at a loss in order to obtain the necessary funds. You can limit that risk with an emergency fund.
Tip 2: Know yourself: There is nothing worse than watching your investment go down every day. Panic sets in and you want to stop the pain by selling. Remember your plan is to buy low and sell high. The goal is to make money not to lose money. Are you selling because you cannot deal with the price fluctuation or has something fundamentally changed with the investment? If you do not have the proper risk tolerance, your temperament becomes a risk to your own investments.
Tip 3: Investing for the Long Term: When you invest in the stock market, know that your chance for success increases with time. The market and the economy go through cycles and these cycles can last for years. Patience is required in investing to achieve quality performance. Trying to time the market in the short term greatly increases your risk and few do it successfully.
Tip 4: Buy Quality: Invest for the long term in quality companies and mutual funds. Do not invest a large percentage of your portfolio in risky low priced stocks or low quality bonds.
Tip 5: Beware of Stock Tips: In the world of the stock market, there are folks who will “pump” a stock so you buy and “dump” it quickly before you can sell. Do not invest because of mail advertisements or tips at the Friday night party. You will be taking a high degree of risk if you do.
Tip 6: Dollar Cost Average into your Investments : Plan to invest systematically. invest at regular intervals monthly or quarterly. This will help you average a lower net cost over time and will reduce your risk of buying at the wrong time.
Tip 7: Diversify with Mutual Funds: Mutual fund investments reduce your risk because they are a diversified investment. When you buy a share of a mutual fund you are buying an interest in the hundreds of companies and related industries that the fund invests in. For small investors, a portfolio of stock and bond mutual funds achieve excellent diversification at a low cost. Investments should also be made in foreign stock and bond mutual funds. Also, mutual funds that invest in natural resources like silver, gold, and oil can provide even more stock market diversification with an inflation hedge.
Tip 8: Diversify with Stock and Bonds: A diversified portfolio should have both stock and bond investments. A stock or bond portfolio of investments in individual companies would require an investment in many companies across different industries to achieve proper diversification. Investors with large sums of money generally would use brokers or financial planners to achieve this diversification.
Tip 9: Keep some money in Money Market Funds: Keep some money in money market funds or cash. If the market dramatically falls you will be able to invest at the discounted price.
Tip 10: Reallocate Annually: Review how diversified you are on an annual basis and make adjustments accordingly. The beginning long term conservative investor, should use dollar cost averaging to invest in stock, bond, and mutual funds to attain a diversification of 40% domestic stock, 10% natural resource stock, 10% foreign stock and bonds, 20% domestic bonds, and 20% cash. With experience, you can adjust the allocation to fit your risk tolerance.
If you follow these ten tips you will have diversified your risk in the stock market. This will allow you to relax and profitably enjoy the rewards of long term financial investments.
James William Smith has worked in senior management positions for some of the largest financial services firms in the United States for the last twenty five years. He has also provided business consulting support for insurance organizations and start up businesses. Mr. Smith has a Bachelor of Science Degree from Boston College. He enjoys writing articles on political, national, and world events. Visit his website at http://www.eworldvu.com
