Four more great ways to minimize risk
Ways to hedge against dangers
Risk is especially abundant in the investing world. Thankfully, there’s usually a way to hedge, or protect, against these dangers. I recently wrote about four other risks. Here are four more.
WAYS TO MINIMIZE INFLATION RISK
Despite what the official government numbers say, we all know there’s rampant cost inflation. How do we protect against this with investments? Only a few assets have outpaced inflation in the past 80 years. One is the stock market. Another is tax-free municipal bonds.
HOW TO MINIMIZE INTEREST RATE RISK
A major risk, and temptation, now is to try to get a high interest rate by buying long-term bonds. With interest rates almost zero, that’s one of the worst things you could do. You want to be in very short-term bonds when rates are this low. Or be in alternative bonds.
The average 5-year CD rate is only 1.38 percent. That’s hardly worth tying up your money for five years. If you get into long government bonds the yields are higher but you expose yourself to potentially huge price volatility.
CUT COUNTRY & POLITICAL RISK
These two perils are very similar. Country risk is the possibility that a country will default on their debt. Yet it can also extend to their stock market. If they’re experiencing troubles, just about any asset is at jeopardy.
Political risk is when a government suddenly changes their rules. If the country has major financial problems it increases the likelihood there’ll be sudden changes in laws and policies.
It’s easy to minimize this problem. Diversify your investments into many other countries. It’s a mistake to have all of your income and your investments in only one country. You should have emerging economies and developed foreign countries in your portfolio.
THE MISUNDERSTOOD RISK
This risk is often erroneously referred to as “systematic” risk. It’s actually called systemic risk. Wikipedia.org says this is: “…the risk of collapse of an entire financial system or entire market….” As an example, The Great Recession was a systemic collapse. It didn’t matter what asset or country you were in. There was probably a very large drop in prices or price volatility.
The second confusion is thinking we’re helpless against this risk. I have a lot of respect for Investopedia.com but they goofed on this one. They say, “It is virtually impossible to protect yourself against this type of risk.” Not really. There are a few ways.
Even during the recent downturn, you could have had “short” mutual funds or volatility funds. These can do well when the markets drop or experience high instability. These funds are very aggressive and should only be a small slice of your investments. Yet they can do well when the markets implode.
Another way to protect is by generating very high income from your investments. If you have significant new cash coming in this will protect against a downturn. It also provides a way to buy low, taking advantage of market drops.