Topic: How To Invest

Investor Toolkit: 3 ways to cut your risk in the stock market

Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a new or experienced investor, these weekly updates are designed to give you specific investment advice. Each Investor Toolkit update gives you a fundamental piece of investing strategy, and shows you how you can put it into practice right away.

Today’s tip: “How to be a successful investor by cutting down on your risk”

Many people come up with unrealistic answers to the question of how much risk is right for them. When they’re young and just starting out, many investors decide to abandon a prudent, conservative approach and speculate. They expect to turn a small portfolio into a big one in a hurry, and then move their money into boring, but more dependable investments. Here are several key points to remember:

  • Heavy losses can be especially damaging for young investors: When you’re just starting out in any field, it’s easy to fall victim to ruses and snares that someone with more experience would spot right away. Later on, when you’ve learned how to be a successful investor, you’ll know better than to bid on an ugly painting just because it’s the work of a noted artist, or invest in a building that faces expensive repairs due to delayed maintenance, or buy a promotional stock due to rumours or touting.

    Note that when a young person loses money, the loss is doubly costly. You have the obvious, immediate loss. You also miss out on decades of profitable compounding that can be achieved with a better-quality investment.

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  • Holding fixed-return investments can also be risky: Later in life, some investors make the opposite mistake. They decide in retirement that they are too old to assume any investment risk, and that they should put most, if not all, of their money in more conservative investments, specifically fixed-return investments and government bonds. They work out a budget that shows they can live with today’s 3% to 4% bond yields.

    It’s true that government bonds don’t expose you to any default risk. But it’s equally true that they are not always the best choice for lower-risk investing. Today, they are a particularly poor choice, because they leave you at the mercy of inflation and rising interest rates.

    Right now, the risk of an immediate rise in inflation and interest rates may seem small. But both remain at the low end of their historical ranges. So the next big move is likely to be upward. Meanwhile, taxes weigh particularly heavily on any interest income.

    A two-point cut in your rate of investment return, and a loss of the tax deferral available in stocks, can take an enormous bite out of your capital over a decade or two.
  • Growing more optimistic as share prices rise is especially dangerous: Between youth and old age, many investors repeatedly make the mistake of growing more optimistic (or bullish) as share prices rise. This is the opposite of a sound investing strategy. It can leave you owning the riskiest portfolio of your life just when it can do maximum harm to your finances.

Our investment advice: Well-established companies are the key to profitable and lower-risk investing. Instead of moving between extremes of risk, investors will profit most — and with the least risk — by buying shares of well-established companies with strong business prospects and strong positions in healthy industries.

Of course, any company can run into unpleasant surprises. But well-established, safety-conscious stocks have the asset size and the financial clout — including solid balance sheets and strong cash flow — to weather market downturns or changing industry conditions.

If you’d like me to personally apply my time-tested advice to your investments, you should consider becoming a client of my Successful Investor Wealth Management service. Click here to learn more.

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