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How to be a smarter investor

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Most people obsess about investment performance. While tracking the performance of your investments is without a doubt important, are you considering risk?

Investors generally understand risk. For example, not meeting investment goals stands out as a hazard when it comes to portfolios. But without risk, there is no return. You have to take some risk to earn better-than-average returns.

So, how should you consider risk? How does risk fit into your portfolio? If risk and reward are so heavily correlated, how much should you be taking? How can you manage risk properly?

Understand risk

What is risk, anyway?

You can’t control everything. The recent market meltdown was out of investors’ control. But how you organize your portfolio is within your control. And that’s empowering.

Most Americans investing in residential real estate didn’t think they were taking on a lot of risk. Yet U.S. residential real estate dropped by about 50 per cent from its peak. You definitely increase your risk with all your eggs in one basket. But you can manage risk. You can create less uncertainty and the stronger probability of meeting your investment goals.

Are you taking on too much risk? Is there overlap in the securities or funds you hold? You think you’re well-diversified, but are you really? On the other hand, if you’ve been holding only low-risk, low-return investments like GICs over the last ten years, you might feel sorry. Why? Because if you held a basket of Canadian financials (even with two major stock market corrections), you would still come out ahead. Yes, risk offers the potential for higher returns. However, you need to determine what the appropriate amount of risk in your portfolio is.

In order to create an intelligent investment plan, you need to evaluate your risk tolerance. You need to ask yourself questions like … How much risk are you willing to take? Is a very conservative strategy going to allow you to achieve your investment goals? Research shows that being too conservative also entails risk when it comes to achieving portfolio goals. Risk is not only about aggressive investments. Conservative investments carry risk, too.

Risk, by any other name, is still risk

Risk can take many shapes and forms. Do you have the right investments? Are you being too aggressive? Or maybe you’re not being aggressive enough? The best way to consider risk is by having a sound investment plan.

Considerations for your investment plan

• Asset allocation

• Choosing assets that will make up your allocation

• Rebalancing your portfolio

In an upcoming post, I will discuss the above fundamentals.

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