Investment risk management is a strategy that is used to maintain what the investor perceives as a balance between the degree of risk associated with assets found in an investment portfolio and the potential for earning returns from those same investments. While there are a number of different approaches to investment risk management touted by different financial experts, most follow a simple pattern that boils down to three key areas. The investor must first identify risk currently associated with the asset, assess risk in terms of event probability, and finally reduce the risk by either balancing the asset with returns from a different holding or by replacing the asset altogether.
In order to initiate the process of investment risk management, it is necessary to consider the circumstances of the company issuing the stocks, bonds, or other opportunities included in the portfolio. In terms of the business operation of that company, factors such as the current market share and the possibility of that share changing in the future is important. If there are indications that events such as loss of customers to competitors, changes in leadership, or a decrease in demand for its products in general could occur, this is a sign that the investment may carry a degree of risk that is not in line with the potential gains.
Along with considering the merits and circumstances of each asset found within the portfolio, there is also a need to balance those assets so that the overall integrity of the portfolio is maintained. Investment risk management helps accomplish this by engaging in what is known as asset allocation. By balancing the assets in some manner, it is possible to offset temporary downturns with certain holdings with gains made by other holdings during the same period. For example, if stocks in an airline decline for a period of three months, a balanced portfolio would offset those losses with gains that are made from shares of stock in a booming retail company. This approach makes it possible to reduce risk to the financial portfolio while still holding on to assets that are likely to emerge from the temporary downturn and begin an upward trend that eventually provides a significant amount of return.
Responsible investment risk management is not simply about balancing assets properly. The task also calls for knowing when to hold and when to sell an asset that is headed for a lengthy period of decline. By monitoring trends within the marketplace, it is often possible to determine if events are likely to occur that will adversely affect the performance of one or more assets for an extended period of time. If there is little reason to anticipate a recovery later on, the investor may choose to minimize risk by selling the assets now before the downturn commences. The revenue generated by the sales can be used to purchase different assets that are much more likely to remain profitable.
