Managing Investment Risk
In our previous article, we explored risk as a concept in investment. While it is indeed impossible to have investments without risk, settling for a lower return is not the only way to manage risk. So today, we will explore how to manage risk and still make good returns.
1. Invest in regulated/licensed products
Recently, there has been a spate of angry investors, who, having trusted a money manager with their capital, find themselves unable to withdraw it for one reason or another. Similarly, there are those whose investment managers continue to trade despite sustained losses, depleting investors’ capital. The best way to avoid ending up like one of these individuals is to invest in products that are regulated by the Capital Markets Authority (CMA). Regulation protects investors by ensuring that the fund manager operates within stipulated guidelines and this then lowers risk. To see if the product you have invested in is licensed, visit the CMA website.
2. Stop loss orders
A stop loss order is an instruction that you give your fund manager or broker to stop trading and sell a specific stock once it dips to a certain price. If, for example, you bought Safaricom shares at Kshs 28 per share and place a stop-loss order of 10%, if the share price falls lower than Kshs 25.2, your shares will be sold at the prevailing market price. This is designed to protect you from incurring more loss than necessary in case the share price continues to drop.
MansaX by Standard Investment Bank has a stop loss limit of 10% to safeguard investor capital.
3. Diversify your portfolio
A diverse portfolio earns you the highest return for the lowest risk. You can diversify by investing in asset classes that have varying risk levels and are not correlated. This spreads out the risk because in the event that one asset class does poorly, it will be balanced out by others that do well. It is highly unlikely that all assets, especially those that are unrelated, perform poorly at the same time.
Diversification is especially effective over the long term. Read more about diversifying your portfolio here.
4. Re-balance your portfolio
Diversification is effective, but over time, as some asset classes thrive and others do poorly, your portfolio will become imbalanced. If, for instance you allocate 40% of your portfolio to stocks, and it does well that year, earning you interest, the percentage of your portfolio in stocks will increase, and so will your risk. To avoid this, rebalance your portfolio every so often, redistributing earned capital to other classes, to fit your asset allocation strategy.
5. Position sizing
High risk investments offer the highest return but also exposes your capital. Since you cannot do anything about the risk, simply limit your exposure to it. A 40% loss on a Kshs 200,000 investment will not be as painful as a 40% loss on Kshs 2,000,000, for example. Thus, if you have Kshs 2,000,000 capital, the prudent action is to only invest a portion of it in the high-risk investment and put the rest elsewhere so that you can limit your exposure.
Effective risk management is a crucial part of maintaining a healthy investment portfolio. When deciding on an investment product, consider the fund manager’s risk management strategy as well as the returns you are after. If there isn’t much of a framework in place, that should be cause for concern.
For more information on how Mansax manages risk, contact firstname.lastname@example.org.