3 ways to reduce investment risk
Learn these time-tested ways to reduce investment risk and feel more confident about your financial future.
History shows that when people invest and stay invested, they're more likely to earn positive returns in the long run. When markets start to fluctuate, it may be tempting to make financial decisions in reaction to changes to your portfolio. But people who base their financial decisions on emotion often end up buying when the market is high and selling when prices are low. These investors ultimately have a harder time reaching their long-term financial goals.
How can you avoid making these common investing mistakes? Consider these strategies on how to reduce your investment risk, which could potentially earn you more consistent returns over time:
- Asset allocation
- Portfolio diversification
- Dollar-cost averaging
Strategy 1: Asset allocation
Appropriate asset allocation refers to the way you weight the investments in your portfolio to try to meet a specific objective. It's the act of investing in different asset classes, such as:
- Alternative investments
For example, if your goal is to pursue growth, and you're willing to take on market risk to reach that goal, you may decide to place as much as 80% of your assets in stocks and as little as 20% in bonds. Before you decide how you'll divide the asset classes in your portfolio, make sure you know your investment timeframe and the possible risks and rewards of each asset class.
Different asset classes offer varying levels of potential return and market risk. For example, unlike stocks and corporate bonds, government T-bills offer guaranteed principal and interest—although money market funds that invest in them do not. As with any security, past performance doesn't necessarily indicate future results. And asset allocation does not guarantee a profit.
Strategy 2: Portfolio diversification
Asset allocation and portfolio diversification go hand in hand.
Portfolio diversification is the process of selecting a variety of investments within each asset class, which can help those looking for how to minimize their investment risk. Diversification across asset classes may also help lessen the impact of major market swings on your portfolio.
How portfolio diversification aims to minimize your risk in investment
If you were to invest in the stock of just one company, you'd be taking on greater risk by relying solely on the performance of that company to grow your investment. This is known as "single-security risk"—the risk that your investment will fluctuate widely in value with the price of one holding.
But if you instead buy stocks in 15 or 20 companies in several different industries, you’d be reducing your risk in investment by minimizing the potential of a substantial loss. If the return on one investment is falling, the return on another may be rising, which may help offset the poor performer.
Keep in mind, this doesn’t eliminate risk, and there is no guarantee against investment loss.
Strategy 3: Dollar-cost averaging
Dollar-cost averaging is a disciplined investment strategy that can help smooth out the effects of market fluctuations in your portfolio.
With this approach, you apply a specific dollar amount toward the purchase of stocks, bonds and/or mutual funds on a regular basis. As a result, you purchase more shares when prices are low and fewer shares when prices are high. Over time, the average cost of your shares will usually be lower than the average price of those shares. For those wondering how to minimize their risk in investment, this is an excellent strategy because it’s systematic and can help you avoid making emotional investment decisions.
Have questions? Seek out personalized advice from your financial advisor
If you have questions about these ways to reduce investment risk, consider reaching out to your Ameriprise financial advisor for perspective unique to your financial goals and portfolio. Their personalized advice can help give you the peace of mind to stay the course to your financial goals.
Or, request an appointment online to speak with an advisor.
At Ameriprise, the financial advice we give each of our clients is personalized, based on your goals and no one else's.
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