What are the risks and rewards of investing? They are different for each investor, but there are key principles that can help all investors

What are the risks and rewards of investing? Every case is different, because each individual has different investment objectives, acceptable risk levels and so on. But at the same time, you should generally hold on to high-quality stocks, even if they have moved up substantially in price.

It’s also fair to say that “high risk” investments carry a substantial chance of big losses, as in penny stocks, options and so on.

How Successful Investors Get RICH Learn everything you need to know in 'The Canadian Guide on How to Invest in Stocks Successfully' for FREE from The Successful Investor. How to Invest In Stocks Guide: Find 10 factors that make your investments safer and stronger.  I consent to receiving information from The Successful Investor via email. I understand I can unsubscribe from these updates at any time.

Diversification is a key way to maximize returns and minimize risk

Investors can help minimize the risk of portfolio imbalance by diversifying. This has two benefits. It keeps you from investing too heavily in any industry or sector that is headed into a period of big losses. In addition, by spreading your investments out more widely, you improve your chances of latching onto a market superstar—a stock that will wind up producing two or five or 10 times more profit than average. Over the course of any investing career, you need a few super stocks in your portfolio to offset the losses you’ll have from the inevitable duds.

What are the risks and rewards of investing? To find the best low-risk investments with the best chance of long-term rewards, don’t look for sure-fire patterns

Some investors look for patterns or omens in domestic or international politics, or in demographic data, or in the price of gold. This can eat up an awful lot of time.

These investors often feel they can cut their investment risk by selling some or all of their stocks in times of high risk, and buying them back when risk is low. This never works well for long. After all, risk as portrayed in the media, and genuine market risk, are two different things. No matter how you try, it’s hard to pinpoint market turning points, if only because you have to outguess so many other smart people who are trying to do the same thing.

You’ll rarely if ever sell near the top, nor buy back near the bottom. If you could do that with any consistency, you’d “make all the money in the world,” as the saying goes.

If you constantly worry about the “big picture,” you may at times manage to sell at just the right moment to sidestep a serious downturn. But you may only do that after sitting through a series of downturns. The downturn you avoid may turn out to be the last in a series—the “final leg downward,” as short-term traders like to refer to it.

The next big move in the market may be upward. You need to get back in the market or you’ll miss out. Wait too long and you could wind up paying more than the prices you got when you sold.

What are the risks and rewards of investing in speculative stocks? You may get high returns, but you also take on considerable risk

Speculative investments are higher-risk stocks with uncertain prospects. They are far riskier than what we call aggressive stocks—stocks with sound prospects, but that have added risk in their industry or particular situation. They also typically don’t have the secure hold on the growing, or at least, stable clientele that conservative stocks have.

Speculative stocks can offer significant returns to investors—but they will also have risks to match. High-risk, high-reward investors are typically drawn to speculative stocks.

Apply our 5% to 10% rule for profits in high-quality stocks

You may want to consider selling part of your holdings in a successful conservative stock if it goes way up and comes to make up too much of your portfolio—say, more than 8% to 10%. In that case, it may make sense to take partial profits.

In investing for our portfolio-management clients, we rarely put much more than 5% of a portfolio into any one stock. But if a stock does so well that it comes to represent 10% of a client’s portfolio, we at least consider selling part of it, to cut the risk. However, every case is different.

You also need to consider your diversification across most if not all of the five main economic sectors.

Still, if your exposure to the more-volatile Resources sector gets too high, then you may want to sell some of your Resource holdings, to cut risk.

To do that, start by selling any lower-quality Resource stocks you own, while hanging on to high-quality issues.

What are the risks and rewards of investing? Put the odds in your favour when you use our three-part Successful Investor approach

First, invest mainly in well-established, dividend-paying companies. When the market goes into a lengthy downturn, these stocks generally keep paying their dividends, and they are among the first to recover when conditions improve.

Second, avoid or downplay stocks in the broker/media limelight. That limelight tends to raise investor expectations to excessive levels. When companies fail to live up to expectations, these stocks can plunge.

Third, spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; and Utilities). This helps you avoid excess exposure to any one segment of the market that is headed for trouble.

How has your risk tolerance changed throughout your investing career?

What is the biggest risk you’ve ever taken on a stock, and how did it work out?