To mitigating risk is to reduce the impact of risk upon your portfolio. And that is the mindset that you must have if you want to be a successful investor. Mitigate over eliminate because to eliminate risk is to eliminate ROI. Even if you were to hide your money in a mattress, you have not eliminated risk. For the final frontier in the risk spectrum is inflation, and from that no one can hide.
However, one can mitigate inflation but growing his or her investments at a rate greater than inflation. The problem is that to do so requires that the investor assumes more risk; market risk and the risk associated with the geo-political realities of the times in which we live. There are so many overt and covert risk factors that an investor must navigate, it is almost insane to try to list each one. But there are some basic risk factors that an investor should consider when purchasing stocks.
Recently, a friend asked me to look at a specific stock and give him my opinion. This is something I have gotten in the habit of doing for free since opinions cost me nothing and within a few minutes of my review, I can usually form an opinion. As it turned out, the stock was an ADR (American Depository Receipt). This is simply a negotiable certificate issued by a U.S. bank representing a specified number of shares it holds in a foreign stock traded on a U.S. exchange. The underlying security is held by a U.S. financial institution overseas. (But that is another blog altogether.)
After doing a little research, I informed my friend of the underlying risks associated with this type of investment. I explained to him the exchange rate risks, foreign tax risks, and the country of origin economic and political risks. I did not share with him a buy or avoid opinion, I merely explained the additional risks which are associated with ADRs.
When I am assessing risk, I always ask myself 2 questions. 1. What are the reasons why I should own this stock? I look first, at the opportunities that owning the stock will afford me. Notice the question is not “Why do I want to own this stock?” but rather, “What are the reasons why I should own the stock?” That is a very important distinction. It shifts the focus from feelings to facts. That is the first defense against risk. Emotional investing introduces too much risk into the equation.
The second question is probably obvious to you by now, but I will share it anyway. “What are the reason why I shouldn’t own the stock?” The first question looks at the opportunity and the second looks at the risks associated with the stock. In order to answer these questions, an investor needs to learn how to analyze, not just the company, but the sector, the industry, and the economic cycles, and many other external factors that can impact the price of a stock and its potential for ROI.
A seasoned investor learns to look beyond the risk to see the opportunity. In a way, risk is a kin to emotions… emotions are real, but they are real bad decision makers. Risk is real, but it is a real bad decision maker if it is the sole reason why you choose to buy or avoid an investment. Risk can be mitigated. Remember, to mitigate means to reduce or lessen the impact of a given reality upon your experience.
But how does one mitigate risk? The answer is so simple it might surprise you. Are you ready for it? I can give it to you in a single word… STRATEGY! This year I have committed to executing an options and merger/acquisition strategy. There are systemic risks associated with these strategies, but there are ways to reduce even systemic risks inherent to a strategy. Believe it or not, even strategies include risk. Name one military strategy that was void of risk. There are none. Risk is a product of variables and every investment decision has a number of variables within it.
The way to mitigate the risk associated with a strategic plan is establish rules that govern how you are going to deploy the strategy. So you mitigate risk by conducting in depth research on the company, its sector and industry, recent news reports, analyst’s opinions, market research, P/E ratios, earnings reports and calls, BiB comparisons, product pipelines, foreign exposure, etc.
Based on your findings, you develop a strategic plan on market entrance and an exit strategy if the environment changes. To reduce the risks inherent to your strategies, you establish a set of ground rules that govern how your strategies are to be implemented. If all of this seems to be too overwhelming, welcome to the world of investing. And how do you mitigate the risk associated with being overwhelmed? I recommend you work with a strategic financial coach before choosing a financial advisor.
Some people will have to work with a CFP or financial advisor, but that can actually introduce a new risk into your investing equation. If you have the intellectual ability to, the time necessary, and the will to succeed, a strategic financial coach will be enough. The strategic financial coach works on a fee only basis and is not paid to make decisions for you. He or she is there to provide guidance, not pressure.
Risk comes in all shapes and sizes. It comes in all forms and fashions. It is ever-present in every life decision. There are two ways to deal with risk: lessen its impact on ROI or move away from it totally. The question is “Do you want to be crushed by risk or do you want to crush risk?” You will never be able to escape it, but you can learn to live with it and learn how to use it to your advantage. You see, as you learn how to mitigate risk, you become a lot less emotional about your money. Then, when everyone else is reacting with emotions, you can calmly move in and capitalize on the opportunity, which lies just behind the risk everyone else is trying to avoid.
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