Why Controlling Risk is Critical To Good Stock Market Returns

Let’s say you make an investment you consider risky. Maybe you buy a stock at $100 today and sell it next year at $200. Was it risky? It depends. Maybe the investment was exposed to many risks that didn’t materialize. Or maybe you bought another stock at $100, and it fell to $50 when you sold, marking a 50% loss.

Does that mean it was riskier than the other investment? Not necessarily. The fact that something happened doesn’t mean it was bound to happen. Probable things fail to happen – and improbable things happen – all the time.

Investing involves dealing with the future. The challenge? The future is inherently uncertain. Thus, risk is inescapable. We must confront it.

To mitigate risk in your portfolio, here are three proven actions you can take right now.

Image source: Getty Images.

1. Diversify your portfolio

There’s no way to remove risk entirely. Investors must take on risk to get ahead. After all, risk is part of what makes the whole game of investing interesting. But risk for a 25-year-old, who might be able to recover from numerous downturns, looks much different from a 65-year-old entering retirement. In the latter case, the investor generally will take on less risk.

Either way, consider starting by diversifying your portfolio (25+ quality stocks). The U.S. stock market is broken down into 11 different sectors. A diversified portfolio should have all of them, experts say, including Technology, Healthcare, Energy, and Industrials.

When you have this many stocks spread across various sectors, you mitigate the dent a bad selection might have on your overall portfolio, and you ensure no one sector or industry destroys your portfolio. This doesn’t mean you don’t have conviction about your stocks. It just means you understand risks are inevitable, and diversifying is a hedge against that risk.

2. Conduct in-depth research

Second, research stocks in-depth before buying. It’s temping to buy what’s hot, popular or in the news. But sticking to a healthy amount of research, reading, and learning before making an investment will help separate yourself, and it will help your conviction levels when the stock inevitably turns south (all of them do!).

For example, you can listen to earnings calls to hear directly from top management each quarter. You can research past performance, though it is no guarantee of future return. You also can read about the companies you might want to invest in by browsing books at your local library or reading the latest news. If you’re considering an investment in your favorite brand, for instance, you might check out a book about the company’s founding or evolution.

Without question, there will always be opportunities for investment. Conduct the reading and analysis you need to feel comfortable and confident with your decisions. As you might remember from school: Doing your homework makes you more prepared!

3. Hold for the long haul

Third, hold for the longer term, at least three to five years, ideally more. Markets are up only about 53% of trading days, and history shows that stocks generally perform better over longer periods. Eschewing daily or weekly trading increases your chance of a positive return. It also helps you just keep buying, sometimes via dollar-cost averaging strategies, to remove most of the risk of timing the market wrongly. This also enables you to buy at low prices, during max pessimism, when risk is lessened.

When you maintain a longer time horizon, you generally don’t have to make as many decisions are traders who move in and out of positions by the week (or day!), which saves you time. Long-term investing also could help you reinvest dividends to accelerate compounding. And by staying invested over the long haul, you can weather the inevitable market cycles of bull and bear markets.

Taken together, these approaches generally have led to success. There’s no surefire way to generate good return, of course, but these three relatively simple actions can help insulate your portfolio from risks, especially in market downturns and periods of uncertainty.

10 stocks we like better than Walmart
When our award-winning analyst team has an investing tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

They just revealed what they believe are the ten best stocks for investors to buy right now… and Walmart wasn’t one of them! That’s right — they think these 10 stocks are even better buys.

See the 10 stocks

Stock Advisor returns as of 2/14/21

The Motley Fool has a disclosure policy.

Leave a Reply

Your email address will not be published.