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Investing for The Wealthy

Mitigating Investment Risk

02/14/2019

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Most investments come with an inherent amount of risk. But with the interest rates on savings accounts still at historic lows, buying equities or making alternative, higher-risk investments has become common.
Many people want to invest but are left looking for safe places to put investment income. This article will briefly discuss ways in which to mitigate investment risk and offer some suggestions for investments that are perceived to have lower risk than others, while still offering reasonable upside. Read on to learn more.

Different Investment Strategies

Investment itself is an excellent idea, but as explained above, people sometimes don’t know what to do with their investment dollars. This can lead to predatory behavior from opportunists who want to bilk people with shoddy, get-rich-quick investment schemes.

This isn’t to say that investors can’t see a rapid return on their initial investment, but only to remind investors to be heady and to carefully consider where and with whom to place their investible income.

So, it’s in your best interest to consider the different investment strategies available to you, and to explore those with an acceptable level of risk. Below are a few common investment strategies, along with ways to mitigate the risk of each.

Equities or Stocks

It’s generally agreed upon by financial experts that equities (or stocks) offer the largest potential reward, but they are inherently risky. Investors can potentially lose everything that they put into a given equity, unless they are collecting dividends.

Not all equities are created equal. Equities which tend to climb steadily are considered to be “blue-chip” stocks, and as one would expect tend to be more expensive to buy into. This is due to the expected growth and return on initial investment.

First-time investors and those leery of buying into equities can investigate lower-risk options such as index fund investment as they do diligence on and become acclimated to stock trading.

Investing in historically reliable stocks is a good way to mitigate risk, but again, any equity can plummet with no warning. Sometimes, all it takes is one poor business decision or a public-relations fiasco for a given stock to crater.

So, understand as an investor that you are taking on a level of risk if you choose to primarily invest in equities. It will then be incumbent on you to be honest with yourself about what level of risk are acceptable.

Bonds and CDs

Bonds and certificates of deposit are two time-honored places to put investment income. Both types of investment are also historically low risk.

The issue with both bonds and CDs is that they mature extremely slowly. Investors who want to take a more active approach or who don’t have the patience to watch a small percentage slowly accumulate will not to invest in bonds or CDs exclusively.

One investment researcher determined that stocks simply do better than bonds over the long-term, with investors on average seeing a 10% yearly return while those who bought government bonds saw an annual return between 5-6%.

But as noted above, many stocks come with quite a bit of risk. Bonds may appreciate slowly, but they do generally guarantee a gradual return on investment, if they are left alone to mature and not cashed-out early under penalty.

Other Things to Know About CDs

Meanwhile, CDs rightly or wrongly have the reputation of being “boring and predictable.” But some seasoned investors love CDs for this exact reason, as CDs lower risk significantly while nearly guaranteeing ROI.

CDs should be viewed as an investible alternative to a savings account, with the caveat that funds can’t be withdrawn on a whim. This could be a boon to less disciplined investors who are apt to pull from their savings accounts with little provocation.

Tools such as CD calculators exist to help investors estimate how much return they can potentially see if they put a chunk of money into a CD and leave it alone to mature.

CDs currently offer Annual Percentage Yields (APYs) around 3%. In most cases, CD would work better with larger initial investments. A $500 CD left alone for five years at an APY of 3.15% would generate $181.81 in interest earned. There is some upside to CDs, even if CDs or bonds shouldn’t be your only investment.

For most investors, it’s not a bad strategy to put a bit of investment income into bonds or CDs, as both come with very little downside. But investors should be prepared to sit on these investments for a number of years.

REITs or Real Estate

Real estate has become an extremely popular investment, so much so that Real Estate broke off into its own stock market sector in 2016.

While real estate is a tantalizing way to diversity a portfolio, it comes with a number of specific risks.

For example, an investor assumes sponsor risk, as investing in real estate means not only trusting someone to scout and develop a given area, but also trusting someone else entirely to manage the property and nurture your investment.

For hands-on investors who opt to scout and purchase their own real estate, a whole new crop of problems arises.

Risks Involved

By renting out a property to a single tenant, for example, the investor assumes the risk that the tenant will not pay their rent on time (or at all), or that the tenant will vacate the unit at the expiration of the lease.

These issues don’t even factor more practical concerns such as housing maintenance costs or unforeseen structural problems with a property.

These are just a few of the potential risks that an investor can incur. Thankfully, there are ways to limit these risks while still reaping the potential rewards of real estate investment.

Addressing the examples listed above, developing a relationship with a good housing inspector and carefully screening potential tenants are two ways to mitigate some of the more common risks that go hand-in-hand with real estate investment.

Mitigating Risks Through REIT

Another way to mitigate risk in real estate would be to invest into a Real Estate Investment Trust, or REIT.

REITs have become very popular among investors because they allow individuals to buy shares of commercial real estate groups or portfolios and generate income from numerous properties. This limits the risk of a single property causing problems or a loss.

A REIT could include any number of properties or developments, including hotels, apartment buildings, offices, self-storage, and more. REITs are generally a lower-risk way to invest in real estate, leading to their prevalence and popularity.

Mitigate Risk to Invest Smartly and Safely

Investment is always a wise strategy and doesn’t have to be daunting in any way. While higher-yield investment strategies tend to come with a bit more risk, there are a number of tactics investors can use to limit these risks and mitigate risk factors.

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