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Risk and Portfolio Management
One of the phobia of investing is the concept of risk, which can be broadly defined as the probability of an adverse outcome or chances of not realising your required rate of return on your investments. Investors purchase shares with the intention of realising positive returns(i:e making money) but in some instances negative returns( making a loss) are realized due share price moving against that intention. The relationship between risk and return needs to be understood before investing in financial securities as lack of such information could have dire consequences for the investor.
Risk management in general, provides strategies, processes, tools to monitor, recognise and deal with a risky event. It can be a complex issue depending on risk appetite of the investor, the products that you have invested in and the methods used to manage/minimise risk e.g. using derivative products such option and future contracts.
A portfolio of shares, that is, a group of different of shares, is constructed with the intention of reaching the investor’s objectives. Investing in shares belonging to the same company is generally considered risky because should the share price fall permanently, the value of your investment might be affected greatly because of the lack of a buffer system to counter that situation.
Diversifying the risk by investing in shares from different sectors remains the popular risk management strategy. A prudent investor heeds the advise not to put all his/her eggs in one basket. Shares are selected on the basis of
- being forecasted to produce future returns desired by the investor.
- being influenced by factors that will not impact negatively on all shares in the portfolio.
- shares are correctly weighted according to the agreed client’s mandate or market guidelines.
- where possible, comparing your portfolio return (benchmarking) with an appropriate index such JSE’s top 40 index, if they are based on similar terms. This is normally done to access if your strategies are much away or closer to the market as whole
The portfolio need not contain only shares but can include other securities such as bonds, property investments, cash investments and in some cases derivative instruments.
Derivative instruments are high risk instruments that are used to hedge/offset unfavorable price movements in a portfolio. A through knowledge of how they work is recommended before using them.
Risk management is a dynamic and an on-going process which changes when factors like age, dependants, political and socio-economic issues changes. One should get professional help in portfolio management matters e.g. stockbrokers.
We cannot shy away from risk or eliminate it entirely; it will always be part of investing.
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