Friday, June 10, 2005

Ways to take on more risk 0 comments

(P.S: Sorry for any disturbances the advertisements above may have caused you)
Now you may ask: why the hell would you want to do that. Well for the simple reason that return and risk are typically directly related, so if you want to crank up your expected gains then you must be prepared to take on more risk.

There are quite a number of ways to achieve this, but I will mention a few main approaches: money allocation, use of leverage, asset class allocation, stock selection.

Money allocation- How much of your own equity that is allocated to investments
You typically increase risk when you increase investments and reduce cash holdings.

Leverage- Borrowing, such as broker margins, to increase allowable purchases
This is the other form of funding, besides personal equity. Debt typically increases returns several fold in good years, but clearly increases risk.

Asset allocation- Allocation of money in different asset classes
In terms of risk, it is futures, equities, index-linked funds, bonds, money in the bank in descending order. How the money is allocated among these instruments determines portfolio risk.

Stock selection- Types of stocks/sectors bought into
Some prefer highly volatile sectors like technology or cyclicals, while others like the good old investment grade stocks like blue chips, utilities or consumer staples.

I typically focus on increasing my risk exposure through investing a large proportion of my money in stocks, but I control it through no use of leverage and employing a stock selection process which stresses presence of margins of safety (eg. low PE). Others might have their own methods, such as diversifying their asset class allocation into bonds for example, or employing higher levels of cash holdings. It is up to the investor because managing risk is in essence a qualitative exercise, but ultimately these issues have to be thought through and constantly monitored.




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