Managing A Stock Portfolio Investment Risk

Best Growth Stock – Risk is different from mere uncertainty. It is possible to analyze the risks inherent in an investment, and manage them in such a way as to increase your likelihood of returns and decrease your chance of losses. By strategically managing investment risk, you can take advantage of the higher return potential of higher risk investments.

The most common risk management strategy is diversification: combining investments in different kinds of assets into one portfolio, so that no one set of economic or market factors will have too great an impact on the overall value of your investments. For example, if you invested all of your capital in petroleum stocks, a drop in gasoline prices could have a devastating effect on your portfolio. However, if you combined your petroleum stocks with investments in an industry that would benefit from a drop in gasoline prices—automobile manufacturing, for instance—the rise in one stock would offset the drop in the other. The heart of Modern Portfolio Theory is to manage the risk-return relationship of a portfolio so that it gets the maximum return for the risk it accepts, and so that it accepts as little risk as possible to achieve a given return.

The most common risk management strategy is diversification. One of the most effective diversification techniques is asset allocation: apportioning your investment capital among different asset classes (stocks, bonds, cash equivalents, etc). Research has shown that the way a portfolio is divided among asset classes is a better predictor of how well it will perform than which individual stocks or bonds are included. Using asset allocation, you place a portion of your capital in more aggressive investments in the stock market, like stocks, and another portion in safer instruments like bonds.

To diversify your investment you might start thinking about investing in the secondary market. The secondary market can best be understood in comparison to the primary market, which is where securities are first offered and sold for the issuing companies by investment bankers. The secondary market is wherever bonds and other securities are bought and sold following their original sale. This trading may take place at an organized exchange—for example, the New York Stock Exchange—or over the counter through a telephone and computer network.

The secondary market is wherever bonds and other securities are bought and sold following their original sale. The corporation or government unit that issued the bonds plays no role in trading on the secondary market. Nor does it receive any profits from these transactions. The investors who sell the bonds receive the proceeds, minus any fees or commissions.

A number of financial professionals implement transactions on the secondary market. A broker usually receives a commission to serve as an intermediary between a seller and a buyer. A dealer is an individual or firm that takes the role of principal in a transaction, buying or selling bonds or other securities on behalf of its own accounts and bearing the risk associated with this trading. A broker-dealer describes many firms, which act sometimes as brokers and other times as dealers for their own accounts. An investor who buys bonds from a broker-dealer purchases the bonds from the firm’s inventory and receives written documentation of this fact.

A specialist focuses on buying and selling one or more types of bonds and stocks for others and on maintaining balance in the securities exchanges. A specialist may trade to even out supply and demand, and prevent wide fluctuations in securities prices. A market maker performs the same buying-and-selling function for the over-the-counter market.

Finally, understanding your investment time horizon can help you increase your risk tolerance in the short term. Holding riskier investments for longer periods of time generally helps you overcome short-term drops in value. The stock market is a good example: even despite disastrous crashes, stockholders who keep their holdings long-term have seen greater gains than those who relied on “safer” investments such as bonds. If your investment goals allow you to hold your investments for long periods, you can benefit by pursuing a more aggressive investment strategy.