Portfolio Risks and Returns - Risk-Reduction Strategies for Stocks

Given the risks outlined above, an IA can take advantage of the following risk-reduction strategies to help protect his or her clients' portfolios:

  • Diversification - diversification was discussed in section 13 as a way to include different types of investments within an asset class. Here, diversification refers to investing in a sufficient number of different issues to minimize systematic (market) risk.

  • Dollar-cost averaging - this strategy calls for a fixed dollar amount to be invested in the shares of a stock or mutual fund on a periodic basis (typically, monthly or quarterly). Therefore, the investor receives more shares when the security price is lower and fewer shares when the security price is higher. Assuming share prices fluctuate during the investment period, the end result is a lower overall cost per share over time compared to the average market price at the time of the purchases.

  • Income reinvestment - interest and dividends from stocks, as well as all types of mutual funds, may end up sitting in a money market account earning very low interest until an amount accumulates that is sufficiently large to be invested.

  • A better strategy is to set up automatic income reinvestment programs, such as:
    • Mutual fund reinvestment - when investing in mutual funds, you can set dividends and/or capital gains to be automatically reinvested in additional shares.

    • Dividend reinvestment plans (DRIPS) - some companies offer shareholders a plan to automatically reinvest dividends into additional shares of stock without paying brokerage commissions.

Look Out!
Be prepared for a question about dollar-cost averaging that may ask about the benefits to investors or calculate cost per share compared to average purchase price.

Measuring Portfolio Returns
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