Risk Management

Risk Management

Suppose you bought  just one stock and put in your investment portfolio and held it for six months. Randomness (the role of luck) would play a huge role in the outcome of your investment. But if we apply a little risk management we can help mitigate our risk. We could buy three different stocks and hold them for a year. By increasing the number of stocks in our portfolio we have decreased the role of randomness in our investment outcome. And the longer holding period will further weaken the role randomness will play in our investments. The more stocks you add and the longer you hold them will further reduce your risk but it will reach a point of diminishing returns where you will be holding too many stocks and it will reach the point where it will reduce the return on your investments. So you have to find that balance between the two extremes. For me in my world I find holding 15 to 20 stocks pretty well manages the risk of being in the market, and the longer you hold them (time diversification) another type of risk can be eliminated as well. The number of stocks you hold in your investment portfolio will be a product of your experience and your approach to investing so there is no magic number. It might be 8 for a person who does a lot of his own research and has the courage of his own convictions. It's more a matter of your risk tolerance and taste. In the end as in all things experience will be your guide.

In the beginning managing your risk will be very much an objective (left brain) activity but after you have the experience of being in the market a few years you will develop more of a subjective approach (right brain). Like the tennis pro who can place a shot just inside a corner, you will develop a certain “touch” and know when to over weigh a holding here and under weigh another over there, when to trim a little from this position and put a little cash aside. Like a chess master you will have a “feel” for where to put your pieces and when to do it.