How to manage the risks when investing in the stock market

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Investing in stocks is one of the best ways to generate higher returns in a low interest rate environment. However, stocks are risky and for this reason many Filipinos do not even want to consider buying stocks as an investment option.

The good news is that there are ways to manage risk, allowing everyone to benefit from the higher returns generated by investing in stocks.

Here are some of the best ways to manage risk when investing in stocks:

Invest for the long term. Studies show that in the short term, the potential losses from investing in stocks can be very intimidating, sometimes reaching double digits. However, studies also show that the losses decrease over time. In fact, those with investment horizons of 20 years and more always generate positive returns greater than the returns generated by investing in bonds.

Given these findings, risk averse Filipinos who want to invest in the stock market should only use money that they will not need in the short term. This could include funds for retirement. Personally, I invest the money that my children receive on Christmas or their birthdays because they will not need these funds before starting their own family.

To diversify. The saying “don’t put your eggs in one basket” applies when investing in the stock market. Don’t just buy a stock or two. After all, many companies that did very well in the past are now significantly less profitable or no longer exist due to disruption caused by many factors, including technology.

An easy way to diversify is to buy mutual funds or mutual funds (UITF) that focus on investing in the stock market. These funds are diversified because the management companies that manage these funds pool the money of several investors, which they then use to buy a basket of stocks. Therefore, even if you can only afford to invest a few thousand pesos, your exposure to the stock market is already diversified.

Avoid buying stocks on the basis of tips. If you have a high tolerance for risk and can handle the volatility that comes with trading stocks, avoid buying stocks on the basis of tips. Certainly, it is very tempting to buy speculative stocks because they have the potential to go up quickly, allowing you to make a significant amount of money in a short period of time. However, speculative stocks can also go down as fast as they go up and investors may have difficulty exiting because when prices fall there is usually a stampede of sellers who want to avoid holding a stock that may become worthless.

Don’t use borrowed money. Another way to improve returns is to borrow money to invest. This is a strategy available for stocks (through a margin loan) and popular for investors who trade forex and commodities (through leverage).

While using borrowed money to invest amplifies returns when prices go up, it also amplifies losses when prices fall. Using borrowed money also increases the risk of losing 100% of your principal, and when this happens, it will be very difficult to recoup your losses.

For example, remember that stock prices fell sharply in March 2020 because of the pandemic. If you owned stocks bought on margin, your broker would have asked you to reduce or fully repay your margin loan. If you weren’t able to comply, your broker would have sold your shares to pay off your debts.

Since your broker sold your shares for a very low price, you have probably lost a significant portion of your capital. You would also have lost the opportunity to participate in the stock market rebound from its March 2020 low until it is today. INQ

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