How can you Minimize the Risk from Your Investments
Most of the people in this world are risk averser this means that normal people are not interested to take high risk for their investment. Although higher risk-taking behavior also can be identified by the highly ambitious people. Actually, they believed in higher the risk higher the rates of return, this type of people want to have abnormal rates of return which is much more than the average rate of return.
Minimize the risk from your investments is a very tough job if you are doing a business of a single product for a particular group of people. But investment in multi-product businesses for a different group of people actually has the potentiality to have a lower or minimum amount of risk. The reason behind this is a diversification of investment which actually helps to lower the investment risk.
Now come to the point of risk minimization of your investments and how it works
There is a widely accepted concept of risk minimization introduced by the Markowitz which is known as Markowitz portfolio theory. This theory says that through forming portfolios (combinations of a different set of investment securities) by using negatively correlated securities from the available investment alternatives investor can minimize nonsystematic (risk which is not generated from macroeconomic variables)proportion of risk. Here unsystematic risk can be close to zero if an investor is able to form an optimum portfolio. Remember that although the nonsystematic/ unsystematic risk is minimized there is still has a systematic risk (arises from macroeconomic variables) that cannot be minimized.
Let’s consider an example of risk minimization
Example 1: Suppose you are doing a retail business of potato supply. You predicted that this year there will be a higher demand for potato, so you stored potato a larger quantity.
But you did not think what will happen if there is less demand for potato because of higher production and huge import from other suppliers.
So there may have a huge risk of losing your business and incurring a financial loss and you do not have any other alternative to recover this loss.
What if you conscious about the consequence that may arise and you invest your money in different products like Banana, Tomato, sugarcane, coconut supply, etc. rather than investing whole money for only one business of Potato supply.
Here in this case if you lose some money from the potato business, you will still have a chance to recover it from the other business you are engaged in. So your risk is minimized by diversification.
Let’s consider another example of risk minimization
Example 2: Suppose you want to invest in the capital market to earn capital gain and yearend dividend. You have many options to choose a company from a different industry, rather doing this you select a company that is doing well in the capital market and invest all of your money. Guess what can be happened to you?
Either you can get a considerable amount of profit or you may incur a huge amount of loss. The problem is you invest all of your money into a particular company, if this company fails then you will lose. So you should your investment decision carefully to form a portfolio by investing in a different company in different industries. So that if any company unable to satisfy then others can recover your loss and you always become gainer from the portfolio.
From these two examples, you can see that only proper diversification can help you to minimize the risk of your business/ investment. So think strategically and be a successful business person.
Points must keep in mind when you try to minimize your investment risk in the financial market
- Choose as much as negatively correlated (one investment return is not related to other chosen investment) investment alternatives.
- Do not invest in the market without knowing what’s really going on. Is the market is over price or under price and what factors and forces changing the current market demand.
- Do not invest in the market if you are found that the price of securities is manipulated by the syndicate.
My suggestion is always to consider investment alternatives and try to diversify as much as you can so that your risk can be minimized and you get a reasonable profit from your investment.