There is no such thing as risk-free investing. All investment portfolios are subject to risk, such as principal risk (the potential for loss of the portfolio’s principal value), portfolio risk (the risk that stated investment objectives may not be met due to a poor balance of risks) and credit risk (the risk of default). Although most investors relish their good luck when their portfolio is on the rise and making gains, they may find themselves in a state of total panic when a downturn occurs.
If you are an investor who has bad investments or a bad investment portfolio and are looking to cut your losses, here are some things to consider that may help salvage your portfolio. These include looking at hedge strategies through the use of options to recoup losses or protect against downside risks, rebalancing a portfolio through dollar-cost averaging and other techniques, and returning to the original investment strategy.
1. Hedging Against Downside Risk
A downturn in the value of your portfolio should be a sign to hedge against further losses. Even if you have adopted a strict buy-and-hold strategy for your investment portfolio, a plan endorsed by Warren Buffet which is based on purchasing stocks and holding on to them for the long term, one mistake investors makes is simply dumping a faltering investment instead of protecting downside risk. Hedging is a fairly common approach that professional portfolio managers use, and these strategies are also perfectly accessible to average, everyday investors. Two simple hedge strategies that can be employed to reduce the impact of a loss in your portfolio are stop-loss orders and buying put options.
A stop-loss is an instruction given to a broker to indicate a price at which to sell a portion or all of a stock holding. As an example, if you were to purchase shares of XYZ Company at $50 per share but were worried that some upcoming news may depress the stock tremendously, you can ask that a stop-loss sell be set at 10% of the purchase price. If the stock falls to $45 a share, this would trigger a sell, limiting your loss to $5 per share. A put option is a security that derives its value from the underlying issue it represents. They are like insurance policies that, for a small premium, allow you to set a price for the stock and, if the market falls, permit you to sell the shares at a higher amount and avoid or minimize your loss. Your only risk is the cost of the contract
2. Portfolio Rebalancing and Dollar-Cost Averaging
Often times, as the value of the market moves up or down, your investment portfolio stop resembling its intended purpose. This means that certain stocks that you want have dropped in value while others have appreciated considerably, posing a challenge as to whether or not you should consider some profit taking. Portfolio rebalancing, a process that should take place on a semi-annual basis, can help you capture profits on some of those stocks doing well and reinvest in shares of issues that may be underperforming but which still show promise. Coupled with dollar-cost averaging, a process of systematic investing over time with the same regular amount in order to buy more when prices are lower, rebalancing can help you maintain keep your portfolio on track.
3. Returning to a Stated Investment Strategy
Another mistake often made by investors is that of chasing returns as opposed to remaining within their stated investment strategy. As tempting as it is to chase after the latest, greatest stock that has been a high riser, abandoning your investment strategy could result in disaster, particularly when that high rising issue begins to lose value. Disciplined investors do their research and pick those investments that provide them with tremendous value over the long haul.
Ryan Delridge is a financial and investment blogger. He is currently researching how to invest in oil wells with U.S. Emerald Energy to better expand and diversify his portfolio.