Investing can be a risky business. When you invest, you are making a bet that your decision will go the right way, and you will turn a profit. However, how do some investors preserve capital and consistently strive to make positive returns? The short answer is risk management.
Before we look at how you can handle investment risk, let’s first look at why handling investment risk is so critical when building a portfolio, even though so many people know it is the only real way to make your investments work. Francesco Coccimiglio, a portfolio manager and investment advisor with Hampton Securities in Toronto, Ontario, with over 12 years of experience addresses this issue and talks about how to manage risk.
The Power of Fear and Greed
The two main reasons why people do not follow proper risk mitigation practices are fear and greed, says Francesco Coccimiglio. When fear is driving an investment strategy, the investor will buy high and sell low. This irrational strategy is considered a way of cutting losses when a bear run begins. When driven by greed, an investor will still buy high and sell low, in this case, buying at the peak of a bull run when a reversal is imminent.
Fighting fear and greed is difficult, but the right risk mitigation measures can help separate your emotions from your trading strategy.
Diversification
When investing, you will often hear things like “the solution to pollution is dilution,” and “diversify or die,” says Francesco Coccimiglio. What these statements mean is that in investing, diversification is the surest way to ensure your portfolio is appropriately hedged. However, many investors shun this advice, opting instead to follow trends.
For instance, when tech stocks are red hot, they will dump everything else and buy tech stocks. When pharma heats up, they repeat the exodus. With such a strategy, all you need is a significant shock to an industry (dotcom crash, for example) and your entire portfolio comes crashing down.
Diversification dilutes the effects of such shocks. If your investments are spread across multiple industries, it becomes difficult for one single event to affect your entire portfolio. However, diversification goes beyond just looking at specific industries. You should also diversify into various asset classes such as stocks, bonds, and alternative asset classes. In this way, you have a variety of investments that can provide lower volatility during inevitable shocks.
Consistency
Consistency is another area many investors fail in when it comes to risk mitigation. According to Francesco Coccimiglio, the main reason for this is that investing is a highly emotional process. With large sums of money at stake, it is often difficult to keep emotions in check. What this leads to is emotional investing. You will hear statements like, “I had a gut feeling this investment would work out.” Such statements are often code for, “I took a wild guess.” In any event, if such a strategy works, it is often the beginning of a reckless investing streak.
However, investing is a marathon, not a sprint. It is not about who can make the fastest fanciest wins but who can consistently grow their portfolio over 10, 20, 30 years or more. When viewed this way, constancy becomes the winning strategy. Consistent investors have a set of rules they always follow no matter what the market is doing. If a specific investment meets their buy threshold, they buy, whether the market is up or down. In this way, they ensure the risks they take are always calculated.
Longevity
Finally, risk mitigation is about ensuring the longevity of your assets. Francesco Coccimiglio has found that what most of his clients struggle with is not making money but staying invested over the long term. For most investors, sustaining an investment portfolio for a lifetime is one of the most challenging things to do. Why? Because most try to game the market and in so doing, succumb to its unpredictable swings. Avoiding this requires long-term thinking.
The best long-term strategies focus on capital preservation first and appreciation second. That means every investment decision must first consider the risk to capital versus the return on the investment. In such a strategy, investment opportunities are evaluated based on the availability of capital preservation protections. For example, fixed income instruments like GICs or bonds may ensure your principal, so that if the stock market crashes, your initial capital is preserved.
The Bottom Line, According to Francesco Coccimiglio
While it is impossible to eliminate risk when investing, it is possible to ensure it is at a low and easily manageable level. Francesco Coccimiglio concludes that attaining this level of investing competence takes time and practice, as well as a thick skin for those times when markets become volatile.
Hampton Securities Limited is a Member of the Canadian Investor Protection Fund and Investment Industry Regulatory Organization of Canada.
This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed and is subject to change. Hampton Securities Limited, their affiliates, directors, officers and employees may buy, sell, or hold a position in securities of a company mentioned herein, its affiliates or subsidiaries, and may also perform financial advisory services, investment banking or other services for, or have lending or other credit relationships with the same. Hampton Securities Limited and its representatives will receive sales commissions and/or a spread between bid and ask prices if you purchase, sell or hold the securities referred to above.
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