What are some of the ways to reduce the risks of investing money?

Stock market volatility is a reminder that investments can fall as well as rise in value, and any investment involves risk.

Yet while it’s impossible to avoid risk entirely as an investor, and you could make or lose money, there are strategies you can use that may help protect your capital.

Here, we consider six ways to potentially help safeguard the value of your investments.

1. Invest in pooled funds

Investing in a fund, such as a unit trust, an Open Ended Investment Company (OEIC), or an investment trust, gives you exposure to a wide range of companies helping you spread your overall risk. You’ll also benefit from the experience of a fund manager who will make investment decisions on your behalf.

By contrast, investing in individual shares takes some skill, and could potentially leave you more exposed to losses, as it relies on the fortunes of a single company rather than the average of many. If a particular company you’ve invested in runs into trouble, you could lose some or all of the money you’ve invested. Of course, no matter where you invest or what strategy you take, there is still the risk your investment could fall in value.

Discover more about how funds work

2. Consider one-stop solutions

You may want to invest in a variety of assets – including cash, fixed-interest bonds, property and equities - to provide some diversification and avoid relying on one particular investment to produce gains. In theory, this may help to reduce the risk of losing money, as the asset types that are performing well can hopefully offset those that at the same time are experiencing a period of poor performance.

Building a diversified portfolio can seem an onerous task, but there are simple solutions available. There are plenty of funds that hold a diverse range of assets, such as Barclays Ready-made Investments. These are funds that include a variety of assets for a hassle-free way to build and maintain a diversified portfolio with global exposure. You can choose the level of risk you’re comfortable with, but remember that higher potential rewards tend to mean a greater risk of loss.

Please remember that this is not a personal recommendation and there may be other investments which may better suit your needs. If you’re not sure where to invest, seek professional advice.

Find out more about Ready-made investments

3. Focus on your long-term plan

Staying invested over the longer term, preferably five years but ideally longer, gives your investments greater chance of positive returns though there can be no guarantees; you can lose no matter how long you hold your investments. This means you may choose to ignore daily or short-term volatility that might occur, while focusing on the long-term growth potential of your investments. It’s also wise to remind yourself why you chose the particular investments in the first place.

While it may be important to check how your investments are performing around once or twice a year, avoid monitoring them too often. It may be tempting to check performance frequently, which can be easy to do online, with the potential that you’ll be prompted to react if there’s a sudden fall in value, and sell at a loss. By monitoring performance only occasionally, you’ll hopefully avoid making unwise decisions to cash them in earlier than necessary.

Read about the importance of staying invested

4. Invest globally

Investing in global funds adds a further layer of diversification, enabling you to include a wide range of stocks from around the world within your investment portfolio, rather than focusing on, for example, the UK and its economy alone. If one region’s stock market suffers a fall in value, gains elsewhere will hopefully make up for these losses.

Global funds may invest in companies in both developed and emerging markets, enabling investors to gain exposure to a wide range of economies with different demographics and dynamics at play. For example, emerging markets often benefit from young populations, and economic growth that can be valuable to investors. However, it’s important to bear in mind that emerging market investments can be particularly volatile and may be less regulated than other markets. They should therefore typically only form a small part of a diversified portfolio of investments.

Remember too that with any overseas investment there is currency risk involved. Investing when sterling is weak will increase the value and cost of overseas investments, while if the pound is strong, this reduces their value.

Learn more about why a global approach might appeal

5. Consider regular investments

Regularly investing money into the stock market rather than putting in a lump sum could smooth returns over time, because you’ll benefit from so-called ‘pound cost averaging’.

This means your investment buys more shares when prices are low, and less when they are more expensive, with the theory being that you’ll effectively pay the average price over a fixed period, which can help smooth out market volatility. However, this strategy, as with any other, won’t always work and you could end up with lowers returns than if you’d invested one lump sum at the outset.

Find out more about the benefits of making regular investments

6. Use a stop-loss order on share investments

Some investors who trade regularly use stop-loss orders to help protect themselves from any sudden market setbacks.

When you put a stop-loss order in place, this means shares will be sold automatically when they reach a particular price. This strategy may be used to protect profits, as well as to limit any losses. For example, a stop-loss order that’s set at 10% below the price will limit your losses to 10%, although how you use this strategy depends on your preferences and attitude to risk.

Read more about how stop-loss orders work

It’s important to remember that no matter what investment strategy you choose, you could still get back less than you put in. If you’re not sure about investing, seek independent advice. Tax rules can change in future and their effects on you will depend on your individual circumstances.

Our passive funds spread out the risk by investing in a number of different assets, whereas typical passive funds only invest in one type of asset. We also have investment strategists making ongoing decisions about where to invest. A lot of other passive funds are just managed by computers rather than people and usually track something, for example a financial index. We combine both these approaches so our passive funds also benefit from some active management.

Active funds

Our Active funds invest in a broader range of assets than our passive funds so you have more potential for growth, as well as benefitting from spreading the risk.

These funds are actively managed, which means a fund manager uses their expertise, experience, and judgement to decide where, when and how much to invest.

This active management means these are more expensive to invest in than our passive funds.

Smoothed funds

Our range of PruFund funds are invested in the Prudential With-Profits Fund. This fund is spread across a wide range of investments, offering potential for higher returns. The aim is to grow your money, while giving you a smoothed investment experience over the medium to long term (which is 5-10 years or more).

Our PruFunds give you some protection from short-term peaks and troughs associated with the stock market. Because of this the PruFund funds are more expensive than the passive and active funds.

The motive of achieving financial goals is to determine the investment ways through which the goals may be achieved by taking minimum risks. But to create wealth or to achieve financial goals with limited resources, one has to take some risks and invest in the instruments having capital risks.

However, there are ways to reduce the risks through diversification, investing throughout the market cycles etc.

“Any investment, big or small, is subject to market risks. The thumb rule to thus, remember is to protect your principal. While risks cannot entirely be predicted or avoided, one can possibly protect the portfolio by being mindful, careful and observant of market changes in order to reduce investment risks. Diversification helps, in more ways than one. Investing in more than one asset class will ensure reduction in unsystematic (investing in one particular company) risks because if/when you encounter a loss, the loss is limited,” said Anil Pinapala, CEO & Founder of Vivifi India Finance.

“What you add to your portfolio matters. If you add a number of non-correlating assets, it will ensure a balanced return because you will always have an asset to fall back on in times when one of your chosen investment assets sees a fall, owing to changes in the market. This thus, smoothens out the volatility of your portfolio. However, be mindful of over diversification,” he added.

Market Volatility: How to keep your investment stable in a shaky market

Despite the need of adding risky investment instruments in portfolio to achieve the financial goals, the risk appetite and risk-taking capacity of an individual also impact the choice of instruments.

“How you invest and what you choose to invest in depends on risks you are willing to or are capable of taking. No two individuals will have the same risk appetite. It is therefore important to identify yours, taking into consideration factors like age, earning, responsibilities (dependants) and your financial goals,” said Pinapala.

“It is advisable to maintain adequate liquidity and seek financial advice before investing, keeping in mind these points. But once you invest, your job isn’t done, it has only begun, because to reduce risks on your portfolio, it’s crucial to understand the market, watch out for any changes that may/may not affect your portfolio, evaluate your investments and rework your asset allocation, if need be,” he added.

Explaining the relationship between risk and returns, Alok Kumar, Founder & CEO, StockDaddy, said, “There can be only four different scenarios when you invest money in any of the stock or any financial asset – Big Loss, Small Loss, Big Profit, Small Profit. Now, what do you think can drastically impact your returns? Yes it’s Big Loss (Say 10-15 per cent in a single trade or 15-30 per cent in a single investment). So we must ensure not to fall prey to such poor risk management practices. Instead, risks must be defined before taking the trades and they should be rigidly defined as per a fixed percentage of your capital.”

“Once you are aware of the money you afford to lose on a particular stock, you must define the quantity you can buy. Finally, don’t put all the eggs in a single basket. You must diversify the portfolio sector-wise and market cap-wise,” he added.

ETF vs Actively Managed Fund: Which one should you rely on to create wealth?

Explaining the importance of analysing the risks before selecting an investment avenue, Nitin Mathur, CEO, Tavaga Advisory Services, said, “Risk is one of the most underrated subjects in the world of financial markets, however, every time there’s a decision to take concerning an investment, the first thought in an investor’s mind should be around the risks involved in a trade.”

Mathur suggests the following basic principles for risk reduction:

1. Ensure that the portfolio is diversified enough. Diversification means to spread out investments across various sectors and not stick to a particular theme or an idea. While over-diversification leads to less returns along with low risks, a concentrated portfolio is a high risk-high return concept only advisable to those who are experts in this field. Investor’s job is to find the middle ground (between over-diversification and concentration).
2. Buy value and buy cheap. The best part about value investing is that it offers the maximum margin of safety as the downside is limited unlike growth investing where uncertainties are high and the downside is huge. Will you consider buying a real estate property at a high price when there are other cheap options available? Same is the case with stocks and mutual funds. Find themes that are available at cheap prices and undergoing temporary downturns but are expected to do well in the future.
3. Maintain a disciplined approach towards mutual fund SIPs irrespective of what is happening in the world. Systematic Investment Planning (SIP) helps in averaging out the NAVs at various levels in the long run. Always prefer SIPs over lump-sum investments, be it stocks or mutual funds.
4. Avoid taking leverage and adding stocks with the help of margins. Pure cash investing is a slow and steady process to win the race. While it takes time, the investor doesn’t have to worry about any repayments.