New to Investing? How to Start Smart and Manage Your Risk
Investing is a good thing. Over long periods of time it can help you build wealth and meet your financial goals in ways that saving alone can’t match. Thanks to decades-long trends that have removed barriers and lowered costs, it is now easier than ever for people to become investors.
Some of the latest innovations that have made investing more accessible include commission-free online stock trading and the introduction of fractional shares, which allow investors to buy smaller, more affordable “slices” of high-priced stocks.
These are wonderful developments, but they don’t change a fundamental aspect of investing—namely, that investing is about balancing both returns and risk. Managing risk is a key to success, whether you’re new to investing or experienced, have a small amount of money or a lot, and whether you trade stocks or other types of securities.
Key risk management principles
Here are some tips to get started—and to follow throughout your investing career:
1. Have a goal and a plan. What are you investing for and how are you going to achieve it? To create a successful plan, you first need to identify what your goal is: a comfortable retirement, the down payment on a house, a trip you hope to take in the next few years? Once you know your goal, ask yourself how quickly you want to achieve it and how much risk you are psychologically—and financially—capable of taking to get there.
More bluntly, how will you react if you lose a lot of the money you’re investing? Can you afford to lose this money? If the answers are “poorly” and “no,” it doesn’t mean you need to stop investing. It just means you need to invest differently to accommodate your circumstances.
For example, if you’re saving for a retirement that’s still decades away, you can afford to take more risk, because your investments have a long time to potentially recover from a downturn. However, if you’re saving for something you’ll want or need sooner, such as a house down payment, you’ll want to invest in more-stable, less-risky investments. This information can help you develop a plan, which will guide you in building an appropriately diversified portfolio for each goal.
2. Diversify. Diversification means spreading out your investments across various types of investments. The classic diversification strategy is to spread your money out across different , such as stocks and bonds, and within asset classes, such as U.S. stocks and international stocks. Each asset class plays a unique role in your portfolio, providing the potential for growth, income, relative stability or inflation protection. Also, asset classes often don’t move in tandem, so when one is underperforming, another may be outperforming. This can help buffer the impact of market volatility and manage the risk/reward potential in your portfolio.
However, even if you’re investing solely in individual stocks, diversification still matters. A portfolio of 20 stocks in a variety of industries will likely be far less risky than a portfolio of two stocks.
3. Rebalance. Even if you do nothing, market ups and downs can skew the relative percentage of stocks and bonds you own, causing your portfolio to drift from its original target allocation. Even a rising market can throw your portfolio out of alignment, weighting it toward riskier assets and potentially exposing you to more risk than you’d like. Rebalancing means selling positions that have become overweight in relation to the rest of your portfolio, and moving the proceeds to positions that have become underweight. It’s a good idea to do this regularly.
Again, even if you invest only in a smallish number of individual stocks, pay attention to how large each stock is to your overall portfolio and don’t let the portfolio get too skewed to any single name or type of stock. Ask yourself what would happen to you psychologically and financially if your biggest position got wiped out or dropped by a large amount. If that scenario is troubling, then that position probably needs to be trimmed back.
4. Watch out for leverage. As discussed above, investing involves balancing the expected risks and returns. Leverage amplifies the magnitude of these factors. If you don’t understand leverage it’s easy to get into financial trouble. Some of the saddest stories regarding investments are when investors were exposed to losses they were blind to, because they didn’t understand the leverage inherent in the instruments and strategies they were using.
No matter how you get started, it’s important to invest in a smart and positive way. Having a plan, a diversified portfolio, rebalancing regularly, and taking a cautious approach to riskier practices can help you invest successfully.
Investing is a journey. You don’t have to know everything on day one, or have a lot of money to get started. You can learn as you go, and explore different investing areas as your needs change or you develop new goals. You can find plenty of how-to articles on both basic and advanced topics at the and pages (they’re open to everyone, not just Schwab clients).
And if you’d like to talk to someone about your goals and get help developing a plan, Schwab is always here to help.