5 Investment Risk Management Strategies to Help Prepare for Market Volatility

It was scary times when the Dow Jones fluctuating more than a thousand points in early 2020 was considered a normal day. And to say that influx of panic was a wake-up call from the market would be an understatement. Times like that have historically happened before and they will happen again. But you’re not going to let that deter you from making smart investing decisions.

Whether it’s related to politics, the economy, or a public health crisis as demonstrated in the past few years, the financial markets are always going to throw investors for a loop due to unforeseen circumstances. But you can do yourself and your portfolio a big favor by being prepared when times like these do occur. And the best way to prepare is to focus on your risk management.

Let's review five key risk management strategies for investors to help protect your investments from times of market volatility.

5 risk management strategies for investors

1. Cash, cash, and more cash

Cash is king. That saying never gets old—and rightfully so. They also say to never time the markets. That saying is also correct. But by having cash on hand, you’re essentially in control and get to deem when a stock is considered oversold. This presents a great buying opportunity.

Having cash not only mitigates your exposure to a tough market, but secures you with emergency funds in case you ever need it. When you repeatedly see mass sell-offs in the stock market, either due to panic, margin calls, or the bears getting greedier, having an extra amount of liquidity will open your eyes to the amount of securities on discount.

2. Diversity is your best friend

And it always will be, regardless of the market conditions. If your portfolio is not diverse enough, you’re not following basic investing principles. And this is something you’ll come to realize when a specific sector underperforms, or worse, when you’re actually in a bear market. So this can’t be emphasized enough, and it's an important risk management strategy for investors.

If diversity is your best friend, then mutual and index funds are your favorite aunt and uncle. As a beginner investor, it can take quite a bit of research if you’re picking individual stocks and want to be considered diverse. Picking the right mutual and index funds based on your risk tolerance reduces that research significantly. Going with funds from any of the reputable investment managers, like Vanguard or Fidelity, will put you in a better position in the long run.

3. Don’t eat the whole pie—take a slice during the opportune moments

Increment buying: if you know nothing else about investing, know this! Investors have made the big mistake of blowing their cash all at once when they see a stock with a significant drop, and then think they’re getting a great deal, only for the stock to go down further. This is why buying in increments is so important. Did a specific stock truly bottom and are you really buying in a validated support zone? This is a question you want to address with full certainty.

So instead of buying once, buy a fraction whenever that stock makes a big percent move down. This is known as averaging down. But remember, averaging down is only effective if that company can rebound when things eventually turn around. More on this when we get to number five.

4. Direct your attention to less sexy investment options

This past decade or so has been the decade of the FAANG stocks: Facebook, Amazon, Apple, Netflix, and Google (more recently, you can add AI-related stocks to this list). Everyone’s in love with tech stocks as if they are bulletproof during the entire 252 trading days of the year; however, nothing could be further from the truth. In a volatile market, these stocks make drastic moves because the market essentially moves when FAANG moves.

Perhaps look at financial instruments like gold, silver, or bonds, if interest rates decline. Or, considering the climate of the past few years, look at the stocks that were least affected by the pandemic. People were staying home, so many businesses were closed. What companies posed the least risk when all of those factors were taken into account?

5. Look for debt-free companies

We may be in a bull market now, but that won't last forever. And in a bear market, the last place where you want your money to be is in a company that is lacking serious cash flow or already has massive debt. It’s bad enough if market conditions are keeping you on edge. Don’t let debt-filled companies with a bad business model make it worse.

Instead, look for quality companies that have relentlessly and consistently proved they can survive horrible market conditions. Take a look at their financial statements, especially the balance sheet. These documents must be publicly disclosed and can be found on a company’s investor relations section of their website.

Smart investors know their risk tolerance

Warren Buffett said it best: “Be fearful when others are greedy and greedy when others are fearful.” As overused as this quote may be in the financial world, it has stood the test of time and encapsulates the five strategies outlined in this article. Let this quote guide you to be a sounder investor who uses logical reasoning as opposed to emotional decisions.

Each person has their own risk tolerance. Some people want faster growth but are exposed to a heavier downside; others want slow and steady growth but their risk isn’t nearly as significant. Regardless of the kind of investor you are, never invest anything you can’t afford to lose. That goes without saying, but it is worth repeating.

As comforting as the five strategies may be to your investing strategy, at the end of the day, investing doesn’t come with zero risks—no investment does. But these strategies can most certainly help you prepare for when those rough days inevitably come. And you’ll unquestionably be a more well-prepared and smarter investor for it.

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