Friday, January 19, 2018

How to Reduce Risk When Investing

I think the biggest reason most people I know have not yet invested in the market is that it is too risky. While it is definitely more risky than a simple savings account, it really shouldn't be viewed as such. 

In the long term the market has consistently gone up. Yes, there have been ups and downs with sharp declines throughout the history, but looking over the long term, the market is up.  

I know you may of heard horror stories of people losing big in the market, but I'm here to show you how you can reduce the chance of this happening. 

To reduce risk in the market you need to do a couple of things:

1. Buy stock in a company that you can understand. Do you understand their business model? How do they make money? Do they have a good product? If you are buying stock in a company because they might have some super advanced technology that no one has heard of or understands, then you shouldn't be buying the stock. 

You should research the stock you are buying. Look at the fundamentals, look at their website, recent news articles, recent product releases, look at the history of the stock, history of earnings, history of dividends. The history can be deceptive because past results aren't indicative of future results. However, I tend to believe a company that continually raises earnings, dividends, and beats estimates more often than not, continues to do so.

2. Diversify.  Do not put all of your eggs in one basket. I like to tell people to take a look at the top 100 companies in the world and start there. What are the chances these top 100 companies aren't going to be around in 5, 10, 15 years?

3. Invest smaller amounts at a time. I invest around $800-$1200 at a time in different dividend growth stocks. This allows me to invest on a regular basis (1-3 times a month), invest in different companies much faster, and minimize the amount I have to pay in trading fees ($4.95) at Schwab. 

By investing a smaller amount you won't have to worry as much about losing it. Now, $1,000 may sound like a lot to you as a beginner investor, but once you build a six figure portfolio, it will only be a very small percentage. 

I currently have about a 90% success rate with all my stocks if you include dividends added. I would say this is very, very good. The unrealized gains on my 90% far outweigh my unrealized losses on my 10%. 

I'm also a believer in buying and holding for the long term. If a stock isn't doing well, but paying me dividends for the next 5-10 years then that will mitigate a lot of the potential losses. If the company goes bankrupt in 15 years I don't really lose all the principal I invested because they will have paid me a good amount back in dividends. This is why I love dividend stocks so much.

4. Don't chase yield. Some people will see a stock yielding 10-15% and think they have found a winner. Usually these companies have some underlying issue and won't be around much longer or the dividend won't last. If you must invest in a company like this, don't invest more than you are willing to lose. 

5. Don't try to time the market. It is impossible to try and time the market. For the past year I've been hearing tons of people calling for a correction of the market and it still hasn't happened. The best thing to do is to constantly buy stock. This way you will buy at the market highs and the market lows. In the long term the market goes up so you will do well. This also goes back to not investing large amounts at once. If you invest smaller amounts more often you will be able to catch the market highs and lows. 

This actually happened with my girlfriend. She wanted to get into investing and had about $5-$10k to invest. The market was at an all time high, but I told her we should just invest because you can't time the market. Well we invested and the following weeks the market went down a few percentage points. I felt really bad, but told her just to wait as it would go back up. Well, that was two years ago and her money is doing very well. Yes, she might have made $100 more, but you can't time the market. If you wait for a pullback and it never happens then you will kick yourself. 


Let me know if you guys have any questions! Any other ways you guys try to mitigate risk?

4 comments:

  1. Nice blog and solid dividend stocks mate. Any particular reason you list your stocks by lots (as opposed to consolidating them)? Very good ways to mitigate risk. The one thing I would add is not to become very comfortable with stock picking. I started out as a day trader and made some sizable profits. Soon realizing that i had Mr. Market figured out. Soon I entered speculative stocks and pretty much lost all my gains. I started to realize my success was a part of a broader bull market :-(

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    1. I guess I should consolidate them on that spreadsheet, but in my personal spreadsheet I keep them listed as lots because I have columns for gain, gain percentage, and then gain with dividends, total gain, and total gain percentage. It is nice to see the differences when I buy a stock a second time on a big pullback. It will also be helpful for me if I need to sell shares of a stock.

      Thanks for checking out my site! Appreciate the feedback!

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  2. I completely agree about understanding what you are investing in. I made that mistake once. Even though I didn't have much invested in the stock, it still hurt when things went south. Nice post!

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    1. Thanks for the feedback! I'm assuming you live in South Carolina! Would love to move to Charleston when I'm financially free!

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