Risk is not a sexy topic. Many readers’ eyes gloss over when they read about the subject. You invest to make money, not worry about the downside, right? Well, good investors do consider their possible downside, so here are some common-sense, down-to-earth ways to control your risk, so that the market’s inevitable potholes never cause fatal damage to your portfolio.
1. Cut your losses short.
Never take a huge loss. Cut all losses short at 15% to 20% on a closing basis. Period.
2. Use market timing.
Avoiding major bear market declines isn’t difficult. You just have to stay on the correct side of the trend! Pay attention to the Cabot Tides. When they turn negative, risk has increased. During these times, it’s best to defer most new buying, and to build up some cash by being tougher on your poorest performers.
3. Diversify by owning at least five—and no more than 12—stocks when fully invested.
Don’t put all your money in just one or two stocks! Sure, if you’re lucky, you could make a bunch of money in a jiffy. But it’s just as likely you’ll end up with a portfolio down a bundle if things go awry. Instead, reduce risk by spreading your money among at least five stocks.
4. Avoid using margin.
We know some investors use margin (borrowed money from a broker to buy more stocks) successfully. But the vast majority of investors tend to buy on margin when everything looks perfect … near market tops! Our recommendations tend to be fast-moving growth stocks, which give you enough bang for the buck without using leverage.
5. Always work toward selling your weakest stock.
When the market takes a slide, it usually takes the lagging stocks down first. So it behooves you to try to sell your weakest stock from time to time, even in good markets.
6. Sell down to the sleeping point.
Lastly, if you find yourself constantly worrying about what XYZ stock will do tomorrow, it’s a sign that you’re uncomfortable with your potential losses. The solution? Sell some shares! Investing should be profitable and fun; it’s not worth losing sleep over.