Risk is inherent in everything we do-from driving our cars to walking our dogs to simply getting out of bed in the morning. There is a chance that something bad could happen, no matter what we do or where we go. It’s a part of life.
But we can’t let fear of potential risks overcome us and paralyze us. Instead, we must keep a watchful eye and plan accordingly to manage and minimize the risks we face.
Equity Market Risk
In wealth management and investing, as in life, risk and opportunity go hand-in-hand. Today, we’ll look at three primary forms of risk people may deal with when investing in equity markets, and we’ll also provide some tips to minimize those risks.
General risk looks at factors outside the equity markets that may influence the markets’ overall movement and risk. From financial risk to political risk to competitor risk, and more, there is a myriad of potential threats that can affect your portfolio.
For example, will the current economic outlook, together with the end of the U.S. Government’s quantitative easing program, result in a rise in interest rates and make bonds a riskier bet than stocks? If so, despite typically higher volatility in the equity markets, stocks might be a lower-risk investment. Also, how will geopolitical events around the world affect the global and U.S. economies, and thus your investments?
Minimize these risks by remaining on top of business and world news so you can stay informed on any global or national trends, as well as potential threats. A trusted financial advisor can also help by using the tools and analytics at their disposal to identify and quantify current risks while forecasting future movements.
Think of market risk as a parallel to the water level in a bathtub (i.e. the higher the water level the higher the risk). If you’re playing with your toy boat (i.e. your stocks) in that bathtub, and the valuation and risks are too high and the market corrects, then the water level will go down and will take your toy boat with it. The opposite is also true if valuation and risks are too low. Then as the water rises, your boat will rise too. And when the market is volatile, as it is currently, we all get a little seasick.
One way you can minimize market risk is by investing in and diversifying into other types of asset classes-that is, other securities and assets that don’t highly correlate with the equity market, such as real estate, natural resources, private equity and hedge funds. So if the equity market goes down 15 percent, then your real estate investment or hedge fund may only go down a fraction of that amount.
Stock-specific risk considers the risks of the company whose stock you hold. Will they become irrelevant in their industry? Could they go out of business in the near future? With the number of publicly-traded corporations in the stock market today, this type of risk can vary greatly. It really just depends on the company’s management team, products and financial performance.
Investors can minimize their stock-specific risk by simply owning stock in multiple companies. It’s generally accepted that if a person owns the stocks of 20 different companies, then they will significantly minimize their stock-specific risk. So should one of the companies in your portfolio tank, then it’s better to take a 5-10 percent punch than a 50 percent knockout.