3 Time-Tested Tips for Lowering Risk

04/19/2012 9:30 am EST

Focus: MARKETS

Patrick McKeough

Editor, Successful Investor

As every investor is painfully aware, investing is not without its risks, so limiting your risk can be one of the best things you can do to improve your success, notes Pat McKeough of TSI Network.

If you follow these three tips, you will eliminate a lot of unnecessary risk from your investing.

Tip #1 for lowering risk: Be skeptical of companies that mainly grow through acquisitions. Making acquisitions can speed up a company’s growth, but it also adds risk that can undermine a conservative, safe investing approach.

Great acquisitions are rare finds. Many acquisitions come with hidden problems or risks, or they turn out to have been over-priced.

Despite the risks, some acquisitions can be hugely profitable. So, don’t automatically discount companies that have grown through acquisitions. Just keep the risks in mind, and avoid companies that seem to push through acquisition indiscriminately without taking into account the potential risks.

Tip #2 for lowering risk: Don’t overindulge in aggressive investments. Aggressive stocks can give you bigger gains than more conservative stocks. But they also expose you to a greater risk of loss. That’s why we recommend limiting your aggressive holdings to no more than about 30% of your overall portfolio.

Ultimately, the percentage of your portfolio that should be held in either conservative or aggressive investments depends on your personal circumstances and risk tolerance. An investor with a longer time horizon or without the need for current income from a portfolio can invest more money in aggressive stocks.

Tip #3 for lowering risk: Keep stock market trends in perspective. It pays to keep in mind that the stock market anticipates things, and no trend lasts forever. Stocks put on lengthy downturns due to business and economic problems. The downturns start going back up long before the problems get solved.

Above all: Be a cautious optimist. Don’t let media sound bites and self-serving predictions warp your decisions when you’re investing in stocks.

Instead, control your risk by following our three-part strategy: Invest mainly in well-established, dividend-paying companies; spread your money across most, if not all, of the five main economic sectors (Manufacturing & Industry, Resources & Commodities, Consumer, Finance, and Utilities); and avoid stocks in the broker/media limelight.

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