Divide and conquer: tips for minimizing investment risks

An investor will always try to obtain the maximum return with the minimum level of risk. Although it is virtually impossible to eliminate this last factor from the equation, several tricks can significantly reduce investment risks.

The Romans showed us how more than two millennia ago. "Divide and conquer," the military and strategists of that time repeated. This advice was put into practice by figures such as Julius Caesar and Napoleon and is still valid today.

Putting all your eggs in one basket can be attractive when a substantial return is promised. But it is generally not a wise move. If the operation goes wrong for any reason, the saver will lose a considerable amount of money.

On the contrary, those who diversify their capital in different financial products, especially if they are very diverse, will be able to cushion the losses in case one of them fails. In this way, they will hardly notice the effect of that fall in their portfolio, as it is compensated by the gains of the others, thus mitigating the investment risks.

What are the investment risks?

Before confirming the operation, it is essential to meditate on all the risks that could condition the obtaining of profits to make wise investment decisions.

When investing in stock market products, there is a risk that the share price may fall and that the profitability may be lower than expected. If this decline is very sharp, it could mean the complete loss of the original investment.

When investing in alternative financing systems such as crowdlending or crowdfactoring, there is a possibility that the company that has been trusted will be unable to repay the amount borrowed. This could trigger a judicial process to force the company to pay back the debt.

However, this situation only occurs in very specific circumstances. Therefore, and to warn savers, several scales have been developed to measure the investment risks. This way, people can easily check whether the product they are betting on involves high, medium or low risk.

Types of investment risks

It is vital to keep in mind that there are several types of investment risks. To begin with, there are systematic risks that are external to the organization and influence the entire market. For example, the outbreak of a pandemic or war causes an increase in commodity prices and a plunge in share prices. Since they affect all companies equally, they are more difficult to avoid, and diversification loses its usefulness.

Next, there are legislative risks arising from the ability of governments to change legislation and the impact of their decisions on the business fabric. For example, governments can encourage investment or punish firms operating within their borders through laws.

On the other hand, there are non-systematic risks closely related to the organizations' activity. For example, if they go through poor sales, competitors take the lead, or if managers are accused of malpractice, their solvency and share price can be severely affected. Diversification is a very useful strategy in these kinds of risks.

There are other investment risks, such as those arising from inflation, a phenomenon that gradually undermines the value of the money invested, or interest rate or currency risks, since the increase or decrease in their value also impacts the profits obtained.

The triangle between risk, liquidity and profitability

Three key aspects coexist in any investment: profitability, risk and liquidity. All three are closely related, so if one increases, the other will decrease. Therefore, savers should examine them carefully to ensure that the investment suits their needs.

What is profitability? The profit earned by the investor as a result of the transaction. It is usually expressed as a percentage of the original amount. For example, if 100 euros are invested at a 2% return, the profit is two euros.

What is the risk? The debtor may not adhere to the established repayment deadlines, or the debt may never be repaid in breach of the terms of the contract. Delays are usually penalized, so you must provide extra interest to compensate the saver for the waiting time.

What is liquidity? The ease with which the invested money can be drawn on again at the desired time. If the investor maintains the ability to withdraw his capital and convert it back into cash without incurring losses, the liquidity of the operation will be very high.

It is common to offer higher returns to compensate for risk, so these two variables usually go hand in hand. The higher the risk, the higher the return, and vice versa. However, this translates into lower liquidity, as the three values work as a balance. The higher the liquidity, the lower the risk and the lower the return. If the saver does not make a large sacrifice, he will not receive a high reward.

Depending on whether the investor is riskier, seeks to maximize profits, or is more conservative and chooses to play it safe, he will go for one option or the other. If the priority is to mitigate investment risks, they will look for alternatives that offer greater liquidity, even if it hurts returns.

Other tips to mitigate investment risk

Portfolio diversification is not the only way to reduce investment risks. First, the saver has to thoroughly inspect all the alternatives available in the market, emphasizing the risks associated with each one of them and avoiding the most volatile options.

A constant analysis of current events and the state of the planet is also of great help. This examination should focus especially on the political, social and economic circumstances that could influence the state of the markets and the sector to which the company in which money is to be injected belongs. Through this effort, it is possible to find out whether the current situation is favorable for investment or, on the contrary, whether the investment should be withdrawn.

It is also advisable to consult the available possibilities with professionals and experts in the field, especially if the saver has limited financial knowledge. Examining the organization's track record and past performance provides a rough idea of its performance and financial health.

Finally, some products open the door to taking out financial insurance to protect the investor, a real security guarantee.

How does Inversa manage investment risks?

Inversa Invoice Market, an alternative financing platform, has a very strong commitment to ethical investment, and we try to help everyone understand the investment risks and design a better investment strategy.

For this reason, we work with two credit rating agencies: INFORMA and Dun & Bradstreet. Then, after assessing the valuation of businesses that apply to participate in our invoice market, we rule out those with high commercial risk or high risk according to these scales. In this way, we raise the protection of savers and try to avoid the risk of non-payment by companies.

In addition to the financial analysis and the analysis of the external credit report, at Inversa, we undertake an analysis of the repayment history of each company within our platform to verify that it has always complied with the conditions and has no outstanding debts.

All these measures build a very robust wall erected to protect investors. But, without a doubt, the most effective advice to control investment risks as much as possible is to listen to the Romans and not to play everything on a single card.