Managing risk is a key part of investing and strategies for achieving the right balance can vary greatly depending upon your specific resources and requirements. You should always expect there to be unpredictable variables involved in any financial decision you make. Risk management essentially involves identifying and analyzing the degree of that unpredictability with a given investment and then determining whether you can accept that level of risk or how you can potentially mitigate it to acceptable levels.
A key means to better ensure the future profitability of your investment portfolio is through various methods of asset allocation. This is the process by which you divide your available capital across various types of investments. The underlying philosophy is that diversification is the best way to mitigate risk and optimize returns.
Identification and analysis of risk
Before we delve into some strategies of asset allocation as a means of managing the risks involved in investing, it’s important to first understand how we determine the risk involved in any given investment. While it is not possible to come up with a concrete, exact figure, there are some means of measurement that will give you a fairly reliable estimate of the potential risk.
Standard Deviation: This measurement looks at past growth and returns in order to better gauge what we can expect to see in the future. By comparing the overall growth of various indices (such as the S&P 500) with the growth of the stock you are interested in over the same period of time, you can see how much it deviated from the general market. This will show you if it has done better or worse than the market as a whole and further, how much it more it fluctuated in the given time frame. The more widely a stock fluctuates in comparison to the general trend, the higher the risk involved in the investment.
Risk cVaR: This is the conditional value at risk. With this method, investors can assess how high the potential returns on an investment are in comparison to how high the risk of loss. In this way, you can see if the potential reward outweighs the potential cost. It is calculated by measuring the amount of potential losses, the probability that loss will occur, and the time frame in which it would happen. It then determines whether those losses exceed the value.