Investing can be overwhelming for a lot of people. This is especially true for younger people who might not have a lot of experience, or for people who have been burned in the past.
New investors constantly hear that they have to balance risk and reward, and have an equal amount of both in their portfolio. There are so many concepts to think about within that larger idea of balance, however.
For example, there are options that range from highly safe but with low returns, all the way to trading penny stocks, which is risky and speculative but can create big rewards.
What is the right mix of risk and reward? How do you combine taking risks that could pay off, with protecting yourself against potentially big losses?
Three of the main considerations to keep in mind when it comes to balancing risk and reward are the horizon, personal objectives, and risk tolerance. For example, if you’re saving for the long-term, you might take more risks with your investments because you have longer to shoulder the burden of losses in the short-term. Of course, these are just the initial concepts to keep in mind.
The following are some things to know about striking a balance between risk and reward when it comes to investments.
Know the Risks of Investment Categories
First and foremost, there are different asset categories, and they have different levels of risk. One of the lowest risk actual investments you can have are government bonds. They have a small annual return, but they provide security and peace of mind.
Next on the scale are corporate bonds. The annual return is slightly higher than government bonds, but still not massive. From there are equities. The riskiest options are small-cap equalities and biotech explorers.
Even just knowing how assets break down regarding risk and reward can be a good starting point, because it can help you create a framework for balancing your portfolio.
Understand the Types of Risks
Different types of risks occur within financial markets, and these are important to understand as well.
For example, market risks are things that don’t have anything to do with the specific company you’re investing in. Market risks are things like inflation or market conditions. Changes in public and economic policy heavily influence market risks.
There are company risks as well. These may not just be specific to the company, but maybe the entire industry it’s in.
Then, there is financial risk which is more related to you at the individual level.
When you’re thinking about personal risks, ask yourself your reasons for investing, the time you have to invest, returns you hope to make, and also your general level of risk tolerance or aversion.
If you’re someone who doesn’t want to take on a lot of risk in your investment strategy, you’re going to have to think about the fact that you’re returns are going to be lower. In this instance, you’re going to have to invest more or invest for longer.
You shouldn’t underestimate the importance of your personal comfort. A lot of people want to go so far in one direction or the other when it comes to investing, that they’re ultimately not comfortable with their strategy and portfolio. You don’t want to feel anxiety about your investments, so try to remember that as you’re making specific decisions.
Mixing Investment Strategies
One of the only real ways to balance risk and reward when investing is to have a diversified and well-balanced portfolio. No matter your comfort level with risk, if you have a balanced portfolio, it’s the best option.
Diversify across not only companies but also sectors. Look at different options from low-priced stocks that are highly risky but could bring strong rewards, to safe, steady bets.
Along with diversification of the actual stocks and asset classes you invest in, you might want to think about mixing what is described as aggressive and defensive strategies. Aggressive strategies allow for maximum returns even over a long investment timeframe, while defensive strategies minimize risk.
Finally, as you look to strike that ideal balance between risk and reward, the best thing you can ultimately do is educate yourself. The more you learn, the more readily able you’ll be to design a strategy that works for you financially and personally.
You can learn not only about the broad terms and concepts related to investing, but also the more specific elements and niche concepts. Take courses online, read guides and try to educate yourself on as many investment options and strategies as possible.