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Good risk management is no different to how you choose to invest your hard earned cash.
If you think a particular investment will go up you will buy that investment (going long to use the terminology). But what if the investment doesn’t go the way you planned i.e. doesn’t go up in price? How much of your money in that investment are you willing to lose (risk) before you get out of it? For organisations what risks of doing business are they willing to accept, mitigate, transfer or avoid?
Depending what your risk appetite is for investing will determine what investments you choose to buy. In the investing world there are different types of investor:
- Income – companies that pay a dividend (3M, McDonalds, AstraZeneca)
- Growth – new companies with serious potential to become established (Apple, Google, Facebook)
- Momentum – companies experiencing serious price appreciation or depreciation (a good recent quarter, new product launch or negative publicity)
- Value – companies that are undervalued relative to what they are worth which the market has not realised in the share price
Careful investors ‘plan their trade and trade their plan’. They work out how much they are willing to lose on an investment BEFORE they execute the trade. Organisations should establish their risk appetite (trading plan) and communicate it via policies, standards etc to their staff who can then implement them. This way a risk culture can be implemented which will help organisations stay within their risk appetite. Regular monitoring of the risks to your organisation will ensure you stay on top of them in the same way traders are carefully watched to ensure they are not over committing to any one trade.
Depending on your objectives for investing (and knowing what type of investor you are) will help you carefully select investments within you risk appetite. Like a targeted attack you should choose the best investments with the highest probability of working out for your desired outcome. As an example if a particular sector is in favour (momentum investing) then look for good stocks that are promising fundamentally, technically or a combination of both. Doing this when the general economy is doing well will additionally swing the odds in your favour.
This analogy does not constitute advice and past performance is not a guarantee of future results.