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Friday, August 7, 2009

Low Risk Investing Strategies

In the past couple years, many of us have taken some pretty big hits in our investment portfolios even in markets that we were told were "safe" or "recession proof."

I don't know about you, but I would like to get nice returns even if the market goes down. Heck, I'd settle for my portfolio staying not losing value and just staying the same during an economic downturn.

And that's what I'm going to talk about today. Some low risk investing strategies to do just that.

Understanding Risk

First, let's start off with an example of risk and why it isn't wise to risk a large percentage of your portfolio on a single trade.

There are some systems out there that have you risking 5% or even 10% of your money on a single trade. And while that's not too hard to make back, the problem occurs when you have a few bad trades in a row.

And if somebody tells you their system never has a losing trade, they're lying. Even the best will have a few losers in a row from time to time.

So let's say you have a few bad trades and your $50,000 account goes to $30,000. That's a 40% loss. Ouch.

So what return do you need to get to make back that 40% loss? Hint: It isn't 40%. It's actually 66.6% that you need to get now. I'll spare you the math, but you're welcome to do it. The reason that it's so much higher is that when you lose money you have a smaller base to work with than before.

Can you see why nearly all professional money managers are only willing to risk at most 2% on a single trade and frequently it's more like .5% or 1%.

That means even if the trader has 10 consecutive bad trades (it will happen at some point to everyone), you'll still only have lost about 20% of the account which can be made up with a few good trades. However, much beyond that 20%, and you're on dangerously thin ice.

Most people think mutual funds and bonds when they want low risk investing, however, exchange fund trading offers a lot of the same benefits that mutual funds do, but with better liquidity, lower fees, and intraday trading ability.

Thanks to Gary_Ruplinger for the article

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