Last week we learnt about various risks factors associated with investing in stock market and this week we shall try to understand various methods of risk management.
Some other important ways in which investors can reduce risks include -
- Constant Learning
- Diversification
- Long Term Investing
- Hedging
1. Constant Learning :
Some of the risks associated with stock market investing can be reduced to a great extent by learning.
In fact Warren Buffet often quotes,
Warren Buffet also credits many of his great investment decisions to his reading habit. He used to read between 600 to 1000 pages per day when he was beginning his investing career, and even today he spends as much as 80% of his day reading.
In fact, when Buffett was once asked about the key to success, he pointed to a stack of books nearby and said,
Read 500 pages like this every day. That's how knowledge works.It builds up, like compound interest.All of you can do it, but I guarantee not many of you will do it.
Newcomers should first try to understand the basics of stock market, fundamental analysis, technical analysis, etc. by reading investment related books.
Investors should also try to gain understanding about the economy in general and working of various sectors. Apart from this investors should spend their time in vital reading to learn about companies in which they have invested money in or wish to invest. Best way is to read annual reports of such companies
Remember, if you are able to understand the basic concept behind the risks involved in stocks, you can control the amount of risk you want to take.
2. Diversification
Some of the risks associated with stock market investing can be reduced by a great extent by maintaining a well-diversified portfolio of stocks from various sectors of the economy.
By maintaining a well-diversified portfolio of stocks from various unrelated sectors of the economy, the weightage of any particular company or a sector in your portfolio gets reduced and hence the impact of risk factors affecting any specific company or sector on your entire portfolio reduces.
I shall explain this concept in detail some time later in detail.
3. Long Term Investing
Some of the risks associated with stock market investing can cause huge volatility in short term by the effect of such risks can be greatly reduced by increasing the investment horizon.
Always remember, a short-term fluctuation won't hurt your well diversified portfolio in the long run as most of the short-term market risks get nullified while investing for duration of 10 to 15 years.
Legendary investors like Benjamin Graham and Warren Buffet always insist on investing for long-term to create wealth. Below are some of their famous quotes -
"In the short run, the market is a voting machine but in the long run, it is a weighing machine." ~ Benjamin Graham
"Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years." ~ Warren Buffett
4. Hedging
Hedging is a risk management strategy which can be used to limit or offset probability of loss due to fluctuations in the price of stocks.
Seasoned market players often protect their portfolios against major downside by hedging it through buying index put options.
In layman's language, hedging can be considered just like buying an insurance policy.
Next week I shall explain you an important investing lesson i.e., Keeping Sufficient Cash Always Ready for Investing.