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Want to reduce your investment risk? Use this strategy…

by , 27 February 2015

One of the biggest mistakes you can make as an investor is having your investments in too few asset classes.

If you put all your capital into one asset class, such as stocks, and stocks crash, it will have a devastating effect.

So what's the best way to deal with this risk?

Read on to find out…

The most important risk-reduction strategy you can follow

The easiest way to combat this risk is to ensure you diversify your investments by asset allocation. In other words, divide you investment capital amongst different asset classes.

This means if one asset plummets in value you have money in other assets which may behave differently. Other asset classes may:

  • Fall, but not as quickly;
  • Hold their ground; or
  • Increase in value.

Let’s take a look at an example to show you how this works in the real investment world…

When the financial crisis struck in 2008, if you had all your money in stocks, you’d have taken a hit. Yet if you’d diversified your portfolio to just two asset classes, stocks and bonds, you’d have fared better.

Having all your money in stocks means your investment capital is entirely dependent on the stock market’s volatility. If you held bonds too, which tend to act in the opposite way to stocks, this would have counteracted some of the plunge you saw in your stock holdings.

Why asset allocation works

The more asset classes you hold, the more diversified your portfolio is and the lesser the effect of a crash in one of the assets you hold. Asset allocation reduces your investment portfolio’s volatility and risk.

There are various ways you can diversify using asset allocation. And the right asset allocation strategy for you will also depend on your attitude to risk.

But by spreading your investment capital across a wide range of assets, you reduce your investment risk and this will help you sleep easier at night.

So there you have it, a strategy to reduce your investment risk.

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Want to reduce your investment risk? Use this strategy…
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