5 Ways to Effectively Manage and Mitigate Investment Risk
Managing and reducing investment risk is a critical concern for everyone, including high earners and disciplined savers. With so many opportunities available in the financial world, it is important to have a plan that is consistent with one’s financial objectives, risk appetite, and future aspirations. Here are five ways that you can enhance your investment risk management efforts. Whether you are an aggressive investor looking for high returns or a moderate investor seeking steady returns, these tips can help you steer through market volatility and stay on track to your wealth creation goals.
1. Know Your Personal Risk Tolerance
What is risk tolerance?
It is the ability to accept losses in a bid to gain potential returns at some point in the future. This is particularly the case among high earners where people’s perceptions of risk differ. For instance, some investors may decide to invest more and try to get back their losses quickly in the event of a loss. Others opt for the safer, slower paths that offer a steady growth within a period of time.
Why is risk tolerance important in the management of investment risk?
When you know your risk appetite, you are in a better position to make rational decisions than being guided by fear or greed. This is because; understanding your risk tolerance is important in making sure that you do not make hurried decisions and your strategies are consistent with your financial future.
Before investing in any project, you should ask yourself:
Do I mind short-term price fluctuations?
What would be the impact of the loss to my financial plan?
Does this investment fit into my overall risk management plan?
2. Include Tax Effects in the Decision Making Process When Selecting an Investment
This is especially important when it comes to the management of income and expenses that are important in protecting wealth. This is because, through proper management of finances, one is certain that all the financial decisions made in the day to day life are contributing to the overall financial goals. It is important to update your budget regularly to be able to control the cash flow, prevent overspending and to maintain financial stability.
How is tax awareness important for effective investment risk management?
Many high earners are not fully aware of how taxes affect investment returns. Short-term capital gains are taxed at ordinary rates and can reduce your returns significantly. High earners in the top income bracket may pay up to 37% in federal taxes on short-term gains. At the same time, long-term gains may be taxed at 20% plus 3.8% extra Net Investment Income Tax if certain income thresholds are met.
Managing investment risk through tax strategies
Hold investments long-term: Invest for the long term in order to take advantage of lower tax rates.
Tax-loss harvesting: To reduce your total tax liability, use investment losses to offset gains.
Tax efficient investments: You might want to include index funds, municipal bonds or other low taxed assets in your portfolio.
Knowing the tax consequences of each investment decision, you can avoid losing your money and meeting some unexpected costs.
3. The Importance of Diversification in Asset Allocation
Why is diversification important?
Investing your money across different asset classes – equities, fixed income, real estate and other alternatives – will minimize the impact of a market downturn on your investments. This strategy is called strategic asset allocation, and it entails identifying different investments that can offer the desired returns with the right level of risk.
How to diversify effectively:
Larger number of asset classes: High net worth individuals may want to include rare collectibles, private equity, or venture capital to increase diversity.
Global exposure: You can also diversify more by investing in international stocks or exchange traded funds (ETFs).
Rebalancing: Check your portfolio from time to time to ensure that it is consistent with your risk appetite and the current market trends.
A well-diversified portfolio is one of the most effective ways of mitigating investment risk because it helps to reduce the impact of economic and market events.
4. How to Have a Good Emergency Fund
This is because even if you have a high income, an unexpected event such as a health issue or a major home repair can make you withdraw funds from investments which are not planned for. This may affect your long term plan and you may end up paying taxes that you had not anticipated.
How to keep an emergency fund healthy:
At least six months of expenses: This is usually recommended as the minimum that should be held in a cash equivalent product.
Select interest bearing accounts: Having your emergency fund in a high yield savings account or a money market fund ensures that the money is working for you in some small way.
Do not use for other purposes: The presence of this fund for real emergencies helps to maintain the investment strategies and policies and makes them less likely to change.
5. Preventive Measures when Managing Retirement Funds
Why is a balanced approach to investment necessary?
Retirement is an area where risk can be particularly costly. With uncertainties like life expectancy, healthcare costs and inflation, it is important to minimize the impact of sharp market movements on your retirement assets. High earners also have other ways to grow retirement accounts, like backdoor Roth IRAs or contributing as much as possible to HSAs while keeping risk in mind.
What are some retirement risk management tips?
Allocate wisely: Incorporate a balanced mix of stocks, bonds, and other fixed-income options in your retirement accounts.
Prudent investing: You should include a reasonable proportion of stocks, bonds and other fixed income instruments in your retirement accounts.
Take advantage of tax benefits: A tax exempt contribution today could mean more money in your retirement account in the future.
Review and change often: It is advisable to check your retirement portfolio on a regular basis and make changes to your investments as you approach retirement or if there is a significant change in the market.
Are you prepared to enhance your Investment Risk Management?
At Falcon Wealth Planning, we offer our services to high earners and growth oriented savers to help them develop their investment risk management plan. We start with your risk tolerance and move through your tax strategy and into the rest of your financial life.
If you need advice, please contact Falcon Wealth Planning to receive a free assessment. We will assess your current portfolio, identify your future goals, and provide recommendations that are suitable for your risk tolerance and visions of the future.
It is important to note that investing is not about eliminating risk but rather about understanding it, preventing it as much as possible, and managing it so that it does not adversely affect long-term growth.
*The content in this blog is for general informational purposes only and does not constitute personalized financial, investment, tax, or legal advice. Falcon Wealth Planning, Inc., a fee-only, true fiduciary, registered investment advisor, provides this information to give a broad understanding of financial concepts and strategies.