Reduce Your Portfolio Risk

By: Jon Provencher
Often, investors get so caught up with how much money they anticipate they will make in their portfolio that they forget about protecting what they already have. As an investor, your first priority should be to protect your capital, once that's organized you can focus on putting your money to work for you.

Protecting your property or privacy is instinctive. There are many ways we protect our property, but one thing very few people do is protect the value of their portfolio. We deposit our money in the bank or in a safe deposit box, without a second thought as to how inflation, market and currency risks will effect its value.

Market risk is a risk you take when you invest in the market. If the particular market you have invested in (stocks, real estate, bonds etc.) declines, the value of your investment will decline. This risk can be minimized by diversifying your money in different markets, this way you reduce the exposure of your portfolio to any one market. If one or two markets experience a decline, the value of your portfolio will suffer less.

Inflation risk is another risk the value of your portfolio faces.

Inflation reduces the buying power of your money. As inflation continues year by year, every $1 you own will be worth less and less, reducing the value of your savings and investments. If you have invested conservatively and have a large percentage of your capital in bank accounts, CDs and bonds, it may appear that you are earning money, with the effect of inflation you may actually be losing money.

Inflation and interest rates affect the Forex market in a pretty predictable way. If one countries interest rate less inflation is higher than another's there's a pretty good chance the value of the currency in that country is going to increase. This happens because international investors seek to invest their currency where it can gain the most, placing more and more demand on the currency which pushes the value up. You can use this predictable pattern to make money in the Forex market.

Many investors choose a selection of investments from their home country for their portfolio. This makes sense, after all, investing in a market you know little about can add additional risk. There will also be a lot more information available for markets close to home than further away, and the availability of relevant timely information is crucial for making decisions. The end result however can be that your whole investment portfolio will be invested in a certain currency, if you're from the U.S most of your investments (the stock market, bonds, real estate) are probably in U.S dollars.

The disadvantage of this is that the value of your portfolio is also exposed to currency risk, if the value of the U.S. dollar drops, the value of your portfolio also declines. If your home currency becomes worth less, the price of imported products will increase and your buying power for an international holiday will also be lower. You can reduce your exposure to fluctuations in your home currency by taking out a hedge in the Forex market.

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