"The only certainty is that nothing is certain." (Pliny the Elder)
When it comes to investments the only way to deal with uncertainty and manage the impact of unforeseen events is to build strict risk controls into your investment portfolio. While the risk of one time incidents cannot be eliminated, through diversification and risk management alone, it's possible to limit the damage when negative events occur such as earthquakes, huge oil price rises, massive frauds (Enron), or sudden company failures.
Consider the following three factors when it comes to your investment portfolio:
- Appropriate asset allocation – identify the appropriate asset allocation where the correct mixture of cash, property, fixed interest and equities will provide the investment return and level of risk you are comfortable to tolerate in order to achieve your financial goals.
- Limit exposure – place limits on the maximum exposure you have to any one stock, bond or property investment. Most fund managers operate highly diversified portfolios within their stated mandate. The real risk comes when an investor holds direct equities and bonds. Inadvertently, they may be doubling up on the investment which a fund manager may already hold thereby creating an unknown or unrealised potential over-exposure to that stock, should it suffer some negative event.
- Review regularly – a portfolio should be reviewed and some believe, rebalanced back to the target allocation (at least annually). This will involve trimming the exposure to those investments that have outperformed in order to stay within risk control limits. Some investors find this very difficult- after all, you are selling exactly those investments that have done the best. However, it is the only way to stay truly diversified and control the risk that accompanies over-exposure to any one stock, industry sector or geographic region. It is a way to get some protection from things that simply cannot be anticipated.
Whilst there are never any guarantees when it comes to your investment portfolio it always pays to expect the unexpected. A sound plan and regular reviews will ensure that your portfolio has a greater chance of meeting your expectations, throughout the good times and the bad.
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