Investment risks and diversification: how to build a safe and profitable portfolio
The choice of a method to balance the portfolio depends on the nature of the risks
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YEREVAN, 16 July. /ARKA/. Investments without taking risks are impossible. Its degree increases with the expected return on investment. If you do not go beyond the risk-free rate, i.e. the rate that allows you only to save money, you will not increase your capital. When making profit-oriented transactions, the investor himself/herself must make the best efforts to create security guarantees.
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The choice of a method to balance the portfolio depends on the nature of the risks. The latter can be divided into systemic and specific risks. The former are related to external factors independent of the investor and affecting the entire market, while the latter are related to the activities of a particular company.
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bSystemic risks include:/b
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- Country risk. It is caused by the emergence of problems in the country, triggered by political or economic crisis provoking a fall in the value of assets;
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- market risks. The risk of a fall in the price of the asset chosen by the investor;
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- the risk of changes in interest rates due to a decision of the Central Bank;
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- currency. Depreciation of the investment currency;
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- credit (default). The issuer loses the ability to pay dividends or coupons to investors;
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- inflationary. When the price level rises sharply, the money depreciates and the investor's returns fall;nbsp;
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- industry-specific. In the industry, to which the issuer's activity is related, the prices for production costs (raw materials, labour) increase, the value of the final product or the profitability of the business, i.e. the efficiency of the use of resources, falls;
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- infrastructural. The intermediary between the investor and the market (broker, management company, exchange) fails to fulfil the obligations under the contract. Often the main reason is geopolitical tension, imposition of sanctions against a particular country: disconnection from payment systems, blocking of accounts, closing of access to foreign platforms for investors.
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- liquidity risk. A financial instrument that a depositor counts on turns out to be difficult to sell on favourable terms.
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An investor cannot fundamentally influence the level of systemic risks. Fidelity to one's own strategy, financial and emotional preparedness for downturns help to counter them.
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When forecasting and describing risks, experts traditionally focus on inflation rates and domestic demand in the world's leading markets (the USA, China and the European Union). The state of key players affects international trade relations.
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Depending on the current global environment, some risks increase and others decrease, so consider the specific circumstances in your approach to minimising losses.
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For example, when inflation is rising, it is recommended to buy assets that will not be critically affected by changes in the financial market: precious metals, inflation-indexed bonds, commodities, and real estate.
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A popular strategy for dealing with infrastructure threats is to invest in the markets of different countries. For example, you can open a pension investment account with a local broker and invest in a foreign index fund.
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The assets of countries with underdeveloped economies and unstable social and political systems should be treated with particular caution.
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bSpecific risks include:/b
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- Business. The company's management makes suboptimal decisions that lead to losses and even bankruptcy;
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- financial. The organisation is no longer able to meet debt obligations to counterparties of the company;
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- operational. Risky are actions with assets that are performed by the investor independently or on the instructions of a broker.
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For protection, an investor should monitor the condition of the issuer. A company's consistent losses, debts, poor annual performance and lack of innovation mean you should not choose its assets.
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If dividends are crucial to you, research the company's payout history and policies. When selecting assets, prioritise issuers that have consistently provided shareholders with a payout, and build a portfolio with a few dividend-paying securities.
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bHow to determine the potential level of risk:/b
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- If we arrange the main instruments from the most reliable to the least stable, we get: government bonds - corporate bonds - stocks of large first-tier companies - high-yield bonds of small and medium-sized companies - stocks (issued by non-blue chips) - futures and options.
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- Exchanges, as a rule, mark assets according to the degree of risk, e.g., assign a rating, place the least stable securities in special sections, designate issuers in danger of bankruptcy.nbsp;
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- Reputable agencies compile extensive and detailed ratings of companies and securities, often including players from different countries.
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bHow to deal with risks/b
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An effective and reliable mechanism to mitigate potential threats is portfolio diversification: allocating capital between different financial instruments whose values are minimally interdependent.
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Another common approach is hedging. Assuming that the underlying assets of the portfolio will fall, investors invest in instruments that will grow in a negative scenario. Hedging is often implemented through high-risk instruments (futures and options, short positions, etc.), so it is not considered optimal for long-term and passive investing.
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bSummary/b
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Don't waste your time and energy searching for a completely safe and profitable instrument - it doesn't exist. What depends on you is not to give in to emotional reactions and diversify your portfolio. This will help to strengthen capital, prepare for the impact of systemic risks and significantly reduce specific risks.
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When confronting potential threats, keep a few principles in mind:
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- As returns increase, the riskiness of the asset increases
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- Each instrument has its own specifics
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- The emergence of certain threats depends largely on specific circumstances
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- When choosing a method to mitigate potential losses, consider the nature of the risks.nbsp; nbsp;br
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inbsp;This article was prepared as part of the joint project Year of Investing in Oneself by ARKA, AMI Novosti-Armenia news agencies andnbsp;/ia href=http://ffin.am/en/iFreedomnbsp;/i/aa href=http://ffin.am/en/iBroker Armenia/i/aa href=http://ffin.am/en/i./i/abr
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