Sharon L. Thornton, The Daily Record Newswire
Investing comes with certain risks. You could be so risk-adverse that you keep all of your money in Certificate of Deposits believing that you are safe, when in fact you may not be earning enough to keep pace with the increasing cost of living. The risk here is that you will not receive enough to fulfill future needs. You may have an over abundance of your money in a single security or industry. Over concentration in a single security opens up Pandora’s Box of varied risks and is only cured by diversification among assets and asset types.
Exploring the concept of risk and breaking it down into two general types, you find the fundamental type of risk is investment risk (losing money) and inflation risk (losing buying power). Beyond these two key types of risk, it can be further broken down into systemic and non-systemic risk.
Systemic risks include interest rate risk, inflation risk, currency risk, liquidity risk and sociopolitical risk. The best defense against systemic risk is to build a portfolio that includes investment which reacts differently to the same economic factors. Non-systemic risks would be categorized as components such as company management and default risk.
You can increase your risk by making frequent changes within your portfolio. Conversely, if you never pay attention to your portfolio, monitor your performance or make appropriate changes, you may not even realize that you have not achieved your investment objectives.
If you fully understand the different types of risk you may face in the investment world and comprehend how to build a portfolio to offset potential problems, then you are starting to manage risk to your advantage.
For most investors the best way to manage risk is with a portfolio that is highly diversified and holds dissimilar types of investments which have the probability of reacting differently to market conditions.
Those who believe that they have an aggressive risk tolerance must tune out the markets’ day-to-day ups and downs. They will have losses from time to time. Unfortunately most investors highly rate their ability to handle risk at the worst possible time — when the market continues upward and stock valuations are high and when the market drops, they become far less confident and may waiver from their investment plan.
To assertively manage risk in investing you must have a solid asset allocation plan. Your allocation plan should be based on your goals, your savings rate and number of working years until retirement. I strongly recommend to the novice investor to obtain professional assistance in formulating an asset allocation plan. Interview your prospective “employees” carefully based on performance over a market cycle.
Once you have a solid asset allocation plan in place, it is fine as time goes on to make minor changes based on your risk comfort level and as your age progresses. Beyond these small adjustments, it is a big mistake to let your emotions take over your allocation plan. This is termed irrational risk aversion.
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Sharon L. Thornton is senior director of investments for Karpus Investment Management, an independent, registered investment advisor that manages assets for individuals, corporations and trustees. Offices are located at 183 Sully’s Trail, Pittsford, N.Y. 14534; phone (585) 586-4680.
