Saturday, 21 November 2009

Techniques for reducing investment risk (Part 3 of 3)

[5] Protect your assets with reasonable stop-loss orders: Professional investors also make wrong decisions, but they possess enough flexibility to admit their faults. If they purchase shares of one company and the price goes down, they usually prefer to sell them at a small loss rather than wait to see if their price climbs back to the previous level.

A stop-loss order is an instruction to liquidate your investment when its price reaches a certain level. Some investors are willing to take a loss of 10% before admitting that they have made a mistake. Know your limits and establish a clear strategy to protect yourself from catastrophic losses.

[6] Save regularly, monthly if possible, in order to ensure that you will also invest during periods of pessimism. Psychologically, it is easier to place your money in the stock market when prices are rising than when the world seems to be falling apart. Nevertheless, periods of economic misfortune tend to be the best to purchase assets at a low price.

This last principle is the most difficult to apply, since it requires enormous self-discipline. If we overreact to painful past experiences, we will overlook great investment opportunities. When the stock markets of the world go through a difficult period, the low prices can offer excellent possibilities for the future. If you adopt the habit of investing regularly, you will be able to make profitable decisions when few are willing to take any risk.

The essential principles of risk reduction will not provide you absolute protection, but they can help you keep your losses to a minimum. Whatever your strategy, check facts for yourself and never trust anybody blindly.

Times of economic adversity are often the best to rebuild an investment portfolio. As Lao-Tzu observed twenty-six centuries ago: “Truth is often paradoxical. Don't make the mistake of believing that you know what you don't know.” Making risk reduction a part of your financial plan can help preserve your peace of mind as much as your savings.


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