Investing is exciting but at the same time very risky. If you do it right you are able to get good return. Alternatively if you takes too much risk you could lose a lot more than you can afford. Risk management is a subject that everyone should know but more often than not this is not a well known subject among the mass.
In the old days stock investment was reserved for the rich and well versed professionals. That was before the popularity of computers where trading stocks require the expertise of stockbrokers. When someone needs to buy a stock they have to call their personal stockbroker to place an order. During this time the stockbroker may provide advise on the transactions. Hence, trading stocks was a risk managed by stockbrokers.
The advancement in technology changed all that; today anyone with a smartphone can place trade by simply pressing a few buttons on a tiny screen. Stock trading become accessible that the regular “Joe” can jump in the bandwagon. Therein lies the problem – most of them are not familiar with stock trading and may have taken in more risks than what they can afford.
I am not a professional in this area but having work in the financial industry for over 20 years I’ve spent enough of my time in reviewing, recognizing and understanding what are risks and how to mitigate them as much as possible. Notice that I said mitigate as much as possible? Well not all risk can be fully mitigated. All we could do is to minimize them up to a level that are acceptable. In other words, what is our risk tolerance.
New investors should consider the following points before investing to minimize risk. There are plenty of news and articles around highlighting how investing guarantee a return that never been seen before in years. Or how investing in “hot” stocks has produced many millionaires. Unfortunately every investors should know this and it is not norm. New investors should never let greed takes over common sense.
Investing Only What You Could Lose
This is a no brainer. You should only invest only assets that you could afford to lose. Never borrow money or use credit card to pay for the investment. This is extremely important because if the market takes a negative turn and becomes a bear market, the value of your holdings can drop at a faster rate. If you only invested only a portion of your “extra” money you are not sacrificing your livelihood. However, if you borrowed money from a lending institution to pay for the investment you are liable to repay the loan regardless on how bad the stock market is performing. If the stock market drops any further you could lose all your investment including your livelihood.
Do Not Put Everything in One Basket
We all heard about the “hot” stock. What do we do when we hear something that is too good to be true. We would invest all on that one stock. If that hot stock continues to go up then the return will be positive. However, all stock has its limit price and sooner or later it will hit the ceiling and start dropping. When that happens, investors of the stock will start panic and begin to dump the stock. In an instant you could see your asset begin to lose value very quick.
Many experts in stock trading advise diversify the portfolio. What that means is instead of just buying stocks, one should invest in bonds or other less risky investments such as mutual bonds. If one of the stocks begin free falling, the likelihood of all investment vehicles to fall at the same time is extremely unlikely. Hence, the risk of losing all the value of your investment is minimized.
Don’t Follow the Trend
If it is too good to be true, then it isn’t. Experts have tried to study the stock market for years and no one can come up with clear explanation why stock market fluctuates so much. History suggests that when the economy is bad it doesn’t mean that the stock market will do bad. In fact trends suggest the opposite. One recent example is when the COVID-19 pandemic hit the entire world various experts warned that the stock market will collapse. Instead the opposite occurred.
Sometimes there are news on how well one company’s stock is doing and there are a plenty of investors. This will create a buy frenzy and the stock of that company will go up. However, when news come out pointing the fact that the stock price is unsustainable, the stock price will instantly drop. One good example is stock price for Nikola. When news came out that Nikola may strike a deal with GM to produce electric trucks, the stock price for Nikola spiked. Recent news reported that Nikola founder committed fraud in its filing brought the stock price to a screeching halt.
Invest in Reputable Companies that Pay Dividend
One of the best ways to minimize risk is by investing in reputable companies that pay dividends. Reputable means the company has been around for years and continue to be relevant in today’s market. Some of the companies that come to mind are IBM, Apple, Microsoft or even John Deere. These companies continue to pay dividends regardless of the state of the economy.
On the other hand, you may not want to invest in companies that have been around for years but failed to adjust to the changing world. Some of these companies failed to adjust their businesses strategically and ultimately cost the demise of their business. Examples include Kodak, which failed to capitalize on the digital photography and Sears/Kmart that failed to adjust to the online presence.
Separate a Portion of Holdings as Play Money
All the points I raised above ultimately resulted in what I called “Play Money”. Stock investing is akin to gambling but legally. That’s why I separate my holdings in “safe” investment and “play” investment. Safe investment refers to less risky investment such as bonds and ETFs. Other safe investments include stocks that are more reliable and unlikely to fluctuate as much.
Play investments are those that are likely to fluctuate and rarely pay dividends. These are usually stocks that I use to flip. However, to be able to flip successfully you will still need to do some research to find out if you are going to make money or lose money. As an example, in the past 6 months I was able to double the holdings on Fastly by buying and selling the stock 3 separate times. Two other stocks that I was able to flip successfully were Snapchat and Pinterest. By separating my holdings I was able to minimize my risk knowing that at least 60% of my asset is safe.
Investing in stock market is exciting and at the same time nerve wrecking. There is no science that explain how the market performs. And there is no rhyme or reason why some company stocks are doing well while others are on the verge of collapse. The only we can do is minimize our exposure to the fluctuations as much as possible. Hopefully what I illustrate above provide an investment strategy that you can follow without worrying about losing it all.
Great post. But I do not particularly agree on IBM, shady accounting and declining revenues. I think a lot of new investors take way to much risk in their portfolios. In my country Norway, every unexperienced retail investors is buying Norwegian(airline), which is on the brink of bankruptcy.