How to minimize your risk as a retail investor
As an individual or retail investor in the capital market, you usually do not have the luxury of having access to deep research by well-paid financial analysts to help you make a smart investment decision. This is unlike institutional and corporate investors like pension funds, hedge funds, private equity among others that have access to well-paid economists and financial analysts who provide them with well researched reports and information to guide them in their investment decisions.
This basically means that a retail investor in the capital market starts from a position of disadvantage since he or she is investing in the same market as these sophisticated investors. It is therefore not surprising that in times of crisis, retail investors, tend to suffer most than institutional investors. This is because institutional investors, because they have access to better information, can exit the market earlier than retail investors.
So as a retail investor, how do you minimize your risk of losing money in the capital market? There are various ways to achieve this and we are going to highlight a few.
It is important that as a retail or individual investor, you understand the investment options open to you in the capital market. Do you want to invest in equities or bonds? Would you prefer index tracked funds, mutual funds or Exchange Traded Funds (ETFs)? Understanding all your investment options and the risks and potential returns that come with each option would help you in making a more informed decision. A common rule is that if the investment is sounding too complicated, then it could too complicated to put your money in.
A more traditional way to minimize your risk when investing is to diversify your portfolio. Individual investors often tend to be carried away by a particular stock or investment that has performed well in the past. Past performance is not necessarily a predictor of future performance. When investing, measuring future performance should be purely based on merit. Investors should avoid concentrating all their money on a particular investment because it has done well in the past. Diversifying your investments across different stocks, bonds or funds helps in reducing your risk. As the saying goes, ‘do not put all your eggs in one basket.’
It is also important not to get greedy or too short term focused when investing. The easiest way to lose money in the capital market is to want to beat the market or desire excessive return. In the 2007-2008 stock market crash in Nigeria, many retail investors bought heavily into the stocks of certain banks in the hope of making huge returns within a short period of time. Of course, those returns never came and the stocks came crashing. There were a lot of Initial Public Offerings (IPOs) during the period, promising returns to investors that were simply unrealistic. Many of those IPOs were never listed on the Nigerian Stock Exchange (NSE) and the anticipated returns never came. Any time a promised return on an investment looks too good to be true, then it is not true. Avoid it.
Another great way to minimize your risk also is to draw a financial road map for yourself before you start investing. What are your financial goals? What do you want to achieve five years from today? What is your present income and how much of it can you afford to set aside for investment purposes? How frequently do you plan to invest, monthly quarterly or once in six months? Having an investment plan before you start investing, helps you measure the level of risk you can afford to take early on.
Whatever asset you decide to invest in, examine closely the cost of making such an investment. If you decide to invest in mutual funds or any fund, do not fail examine carefully the average management fee such funds attract. If a poorly managed fund has a high a management fee, it would eat away at whatever returns you are making on your investment. Some funds charge upfront fees and also a management fee on the returns made on the fund, while some funds charge a flat management fee whether the fund is making money or not.
Do not be afraid to get out of an investment that is performing poorly especially when there are signals that the performance of that investment is not going to improve in the nearest future. Examine your portfolio of investment regularly and feel free to take out the none performing investments and push more funds into the performing ones. Do not get stuck with an investment because you have lost money on it and you are waiting to recover that money before selling. You are likely to lose even more money.
Even though no one can guarantee that you will always make money on your investments in stocks, bonds and other funds, you are always better off investing than holding on to your cash, especially if you live in a high inflationary environment like Nigeria.
5 tips:
1. Be ready to accept risk. Investing has its upside and downside. You lose some and you win some. If you are not ready to lose sometimes, then you are not ready to win.
2. Do not invest like a gambler. The stock market is not the place to gamble on stocks. If you do not have a verifiable reason to invest in a particular stock or any asset class, do not.
3. It is riskier to invest in a bullish market. Most investors find it easier to jump on the band wagon of good times in the capital market, but buying in a bullish market is riskier because there is a higher chance of buying an overpriced stock or asset.
4. Keep a keen eye on your investments. Do not buy an asset and then go to sleep. Be sure to monitor the performance of your assets, whether they are stocks or bonds to ensure that they are performing in line with your set goals or targets.
5. Be bold enough to accept you made a mistake and correct it fast as soon as your assets starts performing below expectation or average market performance. Be willing to sell a poorly performing asset and move your investments into a higher performing one. This is the only way to ensure that the overall health of your portfolio.