Every investment decision comes with its own set of risks and opportunities. Ignoring these risks and chasing high returns blindly could be deeply problematic for a profitable financial future. However, there are some crucial ways to optimize investment portfolios to get maximum risks while minimizing associated financial risks.
Appropriate Asset Allocation
Every investor has a unique perspective on approaching risk according to their financial goals and risk tolerance. Therefore, asset allocation should be mindful of these subjective factors. While asset allocation mostly depends on equity, debt, and cash, these personal considerations also have a key role in handling risks and returns. For instance, an investment company will advise a 30-year old differently from a 60-year old because as people age, their risk tolerance also changes. Some become more adventurous, while some become more cautious. The general rule of thumb is that debt-heavy portfolios can be preferred for shorter time periods of 1-3 years, while equity should be the primary consideration for longer horizons.
Portfolio diversification is a crucial component of minimizing investment risks. Diversification across various asset classes will act as a buffer against market vagaries. For example, if you invest appropriately in real estate, insurance, and a startup, even if one of the asset classes fails, the returns from the other classes should cover the loss. It should be noted that these classes should not be related to each other since related assets tend to fail together. Having too many asset classes could significantly reduce the returns, so a balance needs to be struck. The investment firms should identify the optimum point of diversification that maximizes the returns while minimizing financial risk.
Identify Risks and Risk Tolerance Capacity
Investors should always keep in mind the fact that risks and losses are always a possibility when they invest. Each individual has the capacity to handle risks when they make investments. The extent to which they are able to cope with the risks should be a key consideration when they decide their asset allocation. For example, suppose one cannot deal with the emotional upheavals of high-risk portfolios. In that case, they should prefer to diversify their investments in low-risk, long-period sectors like infrastructure and real estate.
Dollar-cost averaging is a method that helps in the reduction of risks. In dollar-cost averaging, the investor forwards a specific amount toward the purchase of stocks, bonds, or mutual funds on a regular basis. When the prices are low, the investor purchases more shares and vice versa. Over a period of time, the average cost of purchasing the shares will usually be lower than the average prices of the shares. Since dollar-cost-averaging is systematic, investment groups usually recommend it to investors to prevent them from making spontaneous investment decisions and minimizing financial risks.
Regularly Monitor Investments
Investors should always be aware of the developments happening in their investment portfolios. Therefore, it becomes important to keep track of holdings, and a periodic evaluation on a timely basis helps bring the investment risks down. In addition, it would be a good idea to maintain some liquidity by investing in liquid and accessible asset classes. Finally, monitoring investments also nudges investors to adjust their investments appropriately depending on their risk portfolio and financial goals.