3 Simple Ways to Reduce Risks When It Comes To Investing In Shares

More often than not, people unfamiliar with the share market tend to equate investing in shares to a scary and risky venture. But although it is true that the value of a person’s portfolio can fluctuate greatly over his or her lifespan, that’s a very different concept from having a risky portfolio.

The following are three ways that can possibly help overcome the real potential risks that often plague investors when they start on their investment journey; in the process, those three pointers can also help one gain a better understanding of what risk in investing really is about.

1. The first way to minimise risks: Invest for the long haul

There is a reason why one of the most often-trumpeted financial advice out there is to invest as early as possible when time is still on your side. In the short term, anything can happen. External events like the 9-11 terrorist attacks or the SARS (Severe Acute Respiratory Syndrome) crisis that started in November 2002 can cause severe market slumps; for instance, the Straits Times Index (SGX: ^STI) had collapsed by more than 20% from the beginning of 2002 to April 2003 (the latter date was when the market started to bottom-out following the SARS outbreak).

However, when you increase your investing time horizon to 20, 30 or even 50 years, the market tends to ride out those downturns and climb higher. Coming back to the SARS example, at the start of 2002, the Straits Times Index was at 1,625 points; today, it’s more than twice as high at 3,350 points. When you invest for the long haul, whatever happens now probably isn’t a big risk to you.

Perhaps a great example of how long-term investing can make short-term volatility fade away is through my colleague Ser Jing’s previous article. In it, he talked about how history has shown that the longer an investor stays invested in the Straits Times Index, the lower his or her odds of losing money.

2. The second way to minimise risks: Do not put all your eggs into one basket

No matter how good your analysis of a company is, unexpected incidents which can cause the company to crumble could still happen. For instance, a sudden change in consumer preferences or even a virus outbreak can result in some drastic changes to the operations of a business.

This thus brings to mind the idea of diversification. The rationale behind it is that owning shares of different companies from different industries (or even countries) at the same time can help to smooth out the risks that those shares face and help to protect your portfolio from having the potential to be dragged down by a bad event happening to a single company.

However, care must also be taken to not have an overly-diversified portfolio. Billionaire investor Warren Buffett has this saying:

“Diversification is protection against ignorance, it makes little sense for those who know what they’re doing.”

In that vein, you should remember that owning too many funds or shares would up your chances of getting mediocre results. All told, there is a fine line between prudent diversification and over diversification.

3. The third way to miminise risks: Invest in businesses, not shares

Lastly, I have seen my fair share of cases in which people plough their hard-earned money into shares of companies that they have no basic understanding of.

In here, Buffett’s admonition that “Risks comes from not knowing what you are doing” is very apt. And, not knowing what you’re investing in is extremely risky. Thankfully, there’s one simple way to mitigate such a risk and that is to think like a business owner and find shares that you are able to understand.

Let’s say that you are a shopaholic and often hit 3 to 4 shopping malls a day. In that case, you can look at shares or real estate investment trusts that are heavily involved with retail malls. Two such REITs come easily to mind and they are CapitaMall Trust (SGX: C38U) or Starhill Global Reit (SGX: P40U). The former owns 16 retail malls in Singapore which include Bugis+, Raffles City Singapore, and Plaza Singapura. Meanwhile, the latter counts 12 retail and commercial properties under its banner and they are located in 5 countries; in Singapore, the REIT owns Wisma Atria and Ngee Ann City along the Orchard Road shopping belt.

Foolish Bottom-line

I recognise that no matter what we do, risks will still be present whenever we invest. But with inflation silently and steadily eating away at our wealth, and coupled with the fact that there are many ways (I’ve given you three!) in which we can minimise the risks involved with investing, the act of investing itself likely wouldn’t seem that scary after all. And even if there’s still a tinge of fear, remember the saying – Fortune favours the brave.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor James Yeo doesn’t own shares in any companies mentioned.