Tips for managing the risks of your self-directed investment account

Many people these days believe they can manage their investment accounts better than professionals and have chosen to sign up for a self-directed trading service rather than paying an advisor to manage their holdings.

While such a decision might be wise if you are familiar with the financial markets, it may be more important to understand and manage the risks in your portfolio than to increase your returns or beat a certain benchmark.

So, if you have decided to build an investment portfolio on your own, whether for retirement or wealth building, the following tips can help you manage the systemic and non-systemic risks your holdings might face. throughout the journey using tools such as stop-loss orders and the size of the position.

Invest in what you understand

One of the best, but often overlooked, advice ever given by one of the world’s most successful investors – Warren Buffett – is that lay investors should only invest their money in companies and instruments that they fully understand. .

If you are a professional in the financial services, oil and gas, or aviation industry, you will likely feel more comfortable analyzing companies in these industries than tech or engineering companies.

By investing in things that you understand, you can gain an edge over other market participants and this might help you identify opportunities that others cannot see. In financial jargon, it’s called alpha.

Additionally, should the market fall, you will be able to keep your nerves in check as you can determine if the correction is unwarranted or if there is enough evidence to support the decline. This judgment will help you make more accurate and informed decisions.

Follow the principle of the safety margin

Warren Buffett’s mentor, Benjamin Graham, introduced the concept of “safety margin”In 1949 and since then it has become the pinnacle of value-driven investing methodology.

What this concept says is that after you have rated a certain company, you have to assume that you could be wrong with your valuation by at least 25%. Therefore, if the price the market gives you is still attractive enough after deducting this 25% reduction from your valuation, then you should continue investing.

The advantage of following this principle is that you will leave a margin of error on your estimates which is perfectly possible even for the most seasoned investors.

Use stop-loss orders

Stop orders were introduced by brokers to help investors limit their losses by setting a price at which they will be willing to sell their securities in the event the market turns against them.

This price is known as the stop price and it is important for investors who follow a self-directed approach to know what that price is for each of their holdings so that they can set those orders accordingly to avoid huge losses.

The importance of waist positioning

Positioning sizing, also called asset allocation, is a practice of monitoring the percentage that each investment represents in relation to the total portfolio. Most successful investors understand the importance of limiting the size of their positions to avoid being overly exposed to certain sectors of the market or to individual stocks that could drag the entire portfolio with them in case things turn out. wrong.

Likewise, you should limit the size of each of the holdings in your portfolio to a manageable number. Cryptocurrencies are one example. Even if they offer good potential, their withdrawal is sometimes also huge.

Therefore, to avoid a sharp drop in your account balance if the overall crypto market is heading south, you can limit your exposure to these financial assets to 5% to 10% depending on your risk tolerance. .

Final result

Portfolio management investing seems easier than it actually is, as investors might, in some cases, ignore the importance of risk management over the well-advertised importance of seeking return.

In this regard, by following some of the recommendations and tools outlined above, you can increase the chances of producing positive returns on your investments while limiting your losses in case things go as planned.

Posted on July 8, 2021

Source link