While investing in stocks may be more risky than other forms of investment such as savings, bonds, property, etc, it is no doubt, at least historically, that shares have easily outperformed returns from savings or property. In some ways, the clich: ˜higher returns being more risky holds true in some regards.
While any form of investment in stocks will come with some risk, there are ways to keep risks to a minimum.
This is the most well trusted way to reduce risk when buying stocks. In theory, the more diversified a stock portfolio the more diluted risk becomes. In other words, by increasing the range of shares a person holds, they are able to negate fall in values of a few stocks with increase in some others.
Since the purpose of a stock portfolio is to increase its value, the idea is to invest in blue chips in various sectors. This will further reduce risk because, hopefully, downturn in one sector will be countered by upturn in another.
A portfolio will allow you to hold shares in stocks that are ultra defensive and few that are more risky but more likely to offer growth. Of course, for many people companies with a high dividend yield will form the backbone of their portfolio.
Blue chips Another way to buy low risk stocks is to invest in blue chip companies that have a history in increasing their profit and revenues year on year. These are companies that are known for strong financial fundamentals and more resistant to negative economic conditions.
The real advantage of investing in defensive stocks is that they can counter economic downturns much better than companies in more high tech industries like technology because a cut in consumer spending is likely to adversely impact high tech companies more.
For example, even when there is an economic downturn, these defensive stocks can still rise in value because worried investors shift from other sectors such as technology, biotechnology, internet, etc.
Also, these companies do not necessarily suffer in terms of revenues and profit because they provide products and services that able to withstand economic downturns.
One way to ensure a company is relatively low risk is to examine its finances (fundamental data). Most good financial data providers provide access to companies financial history for several years going back. This would allow you to see trends in profitability and whether the company is increasing its revenue consistently year on year. You could also make comparisons with the other companies in the same sector to get a better view of.
The principle of investing in dividend stocks as a low risk investment is based on the idea that companies with high paying dividends are usually have very stable, mature companies that have very consistent levels of income year on year.
Most companies paying high dividends also tend to be very stable companies operating in sectors that are less volatile and prone to less fluctuations in changes to consumer spending .Also, the income from dividends could offset any fall in share price.
A company that is able to increase dividend year on year would suggest they are in a financially strong position. Usually, dividends is one of the first things that is cut back on when a company is experiencing financial difficulty.
Dividend stocks offer near certainty in terms of regular income, some of which offer better returns than a typical savings account.
Tip: Historically, portfolios with high dividend paying stocks making up the largest chunk of the portfolio have outperformed portfolios with less emphasis on dividends after accounting for dividend reinvestments. So, when you are building a portfolio, go with a broker that offers free dividend reinvestments (DRIPS) so long as the company you are investing in offers reinvestment policy, of course.
This can be an effective way to reduce risk of investing in stocks. Stocks with operations in many different countries not being overly dependent on one particular country can better witstand downturns in particular country or region. Oil companies are a very good example of this.
Also, companies with a very multinational outlook tend to exploit opportunities more than companies that operate either exclusively in their own country or just a handful of countries. For example, these companies tend to be more aggressive at seeking out opportunities in emerging economies.
