How to Reduce Your Financial Risk

Investing your capital is a very important decision that involves risks that you must assume. Ideally, these risks should be low and not damage your assets.
How to Reduce Your Financial Risk

Last update: 07 November, 2021

Every investment involves financial risk – that is, the chance that the investment we make will cause us to lose money, or that the profit we expected to make will take longer than expected. To learn how to reduce your financial risk, you need to know that there will always be uncertainty about the returns.

This uncertainty is not the risk itself, but is influenced by several factors. These include changes in the industry in which you’ve chosen to operate, not being able to recover the capital invested, and the inherent instability of the markets.

In this article, let’s review some of the possible financial risks that exist and offer some tips on how to reduce them.

What types of financial risks are there?

It’s not our aim to go too deep into the world of finance, but it’s important to know the most common financial risks that investors face.

For example, credit risk arises when one party defaults on an acquired debt. Liquidity risk arises from the impossibility of one of the parties to assume its commitments, precisely because of a lack of cash.

Finally, we should mention market risk, which is present in the operations that take place in the financial markets. In this context, exchange risk is related to investments in different currencies in which one currency fluctuates. Likewise, interest rate risk arises from a fall or rise in interest rates, such as a mortgage.

Tips to reduce your financial risk

Experts agree that the basis for reducing the financial risks involved in an investment is to have a strategy. We know that “zero risk” is not possible. However, what we can do is to inform ourselves and take some actions to minimize it.

Hombre examina el riesgo financiero.
It’s essential to have an economic strategy to reduce your financial risk to a minimum.

1. Analyze the profitability of the investment to reduce your financial risk

At this point, it’s important to recognize the different types of financial assets, such as bonds, stocks, or cash, among others. Each of them has its pros and cons.

For example, the big risk of cash is inflation, while bonds are safer in this respect. However, they also vary with the interest rate and offer restrictions for their liquidation.

2. Diversify your investment and therefore the risk

Investing in different types of assets is a very good strategy. Therefore, one of the best tips on how to reduce financial risk.

The idea here is to invest in assets that involve different levels of risk. This is called a broad investment portfolio.

Sometimes, the riskiest operations tempt us because their profitability is as high as their risk. However, if they go wrong, we’ll have lost a large part of the capital in just one investment.

That’s why it is recommended to alternate high and low-risk investments.

3. “Cover” your investments to reduce your financial risks

The objective of protecting your investment is to mitigate the risk that is inherent in each of your investments.

So, the best idea is to balance the high risk of a vulnerable asset by investing in another one that gives profits if one gives us a loss. Even if it’s not enough to compensate, at least you’ll have reduced the negative impact.

Here, it’s important to clarify that covering the investment doesn’t imply a direct profit, but it’s there to protect you, as if it were car insurance, for example. We pay the insurance so that it responds in case of an accident and doesn’t generate a significant outlay of money for repairs.

4. Save to be able to spend

If you earned twice as much, would you spend twice as much?

Here, we’re referring to spending everything you earn per month, even if you could save it.

In other words, you may adjust (or misalign) your expenses to your income and not leave yourself a margin to save. In this sense, the concept of financial freedom brings with it the fact that money should be saved (or invested) after having spent what is fair and necessary.

Before investing, we need to have saved a sum that we will make work and grow.

5. Avoid debt to reduce your financial risks

After all, we can’t declare bankruptcy if we don’t have debt and we’re not in the negative.

Although it’s easy to understand that debt is sometimes necessary because the circumstances are pressing, the best idea is to refrain from getting into debt. 

It’s common that people don’t pay attention to the interest generated by a particular loan, for example. And it’s even less common that they take the accounts of how much will be the amount they’ll have to repay when applying for credit.

6. Reduce your expenses

If you notice that your income is in danger, it’s best to save and lead a more austere lifestyle. The idea here is to reduce unnecessary expenses that do not bring meaning or real welfare to your lifestyle.

Ahorro para invertir.
Analyzing family expenses is a first step to determining what’s unnecessary and how much can be saved to invest.

Some final recommendations to reduce your financial risk

Time, perseverance, and decisiveness are three qualities that you should develop if they’re not yet part of your investment personality. Finances are linked to the events that alter the world order, so it’s important that you take the time to be aware of what’s happening in the world to know how to invest well.

You have to be patient and give time to the results of your investments because, generally, they don’t come overnight. Finally, you have to be able to make quick decisions and even change the course of your investments if necessary.

Hopefully, you will be able to follow these tips and the risk of your investments will go down. That way, your profits and finances will increase.

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