Portfolio Risks - Stock Risk Reduction Strategies

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 refers to investing in a sufficient number of different issues to minimize systematic (market) risk. It is also discussed in the Portfolio Management Strategies section as part of the asset allocation process, where it refers to the process of investing in different types of securities, such as stocks of both large and small companies, or bonds from both corporate and government issuers.
     
  • Dollar-cost averaging (DCA)- 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.

    DCA offers protection and opportunity in a sinking market. The article DCA: It Gets You in at the Bottom explains how.


     
  • 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 sufficiently large to be invested accumulates.

A better strategy is to set up automatic income reinvestment programs like the following:

  • 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)- A plan offered by a corporation that allows investors to reinvest their cash dividends by purchasing additional shares or fractional shares on the dividend payment date.

    Learn more about the perks of DRIPS within the article: The Perks of Dividend Reinvestment Plans

Exam Tips and Tricks
Consider these sample exam questions:

  1. An investor owns a small-cap stock with very low trading volume. The investor has a high level of:
    1. business risk.
    2. market risk.
    3. liquidity risk.
    4. purchasing power risk.

The correct answer is "c" - while there is also the potential of business risk, the best answer is liquidity risk because the question focuses on the low trading volume.

  1. Assuming that prices fluctuate throughout the investing period, the use of dollar-cost averaging results in a:
    1. lower average cost per share.
    2. higher average cost per share.
    3. lower market price per share.
    4. higher market price per share.

The correct answer is "a": when prices are lower, more shares are bought, which results in a lower average cost per share.

Introduction


Related Articles
  1. Mutual Funds & ETFs

    How to Reinvest Dividends from ETFs

    Learn about reinvesting ETF dividends, including the benefits and drawbacks of dividend reinvestment plans (DRIPs) and manual reinvestment.
  2. Investing Basics

    Got Dividends? Here's How to Reinvest Them

    Reinvesting dividends is almost always a good idea if you intend to hold your shares for the long term, and there are several ways to do it.
  3. Mutual Funds & ETFs

    Reinvesting Your Mutual Fund Dividends

    Learn the benefits of reinvesting your mutual fund dividends, their impact over time, and when it is better to take the dividend payments as cash.
  4. Retirement

    Should Retirees Reinvest Their Dividends?

    Find out why dividend reinvestment may or may not be the right choice for retirees, depending on their financial needs and investment goals.
  5. Investing Basics

    6 Reasons Why Dividends Should Be Reinvested

    Learn about the advantages of dividend reinvestment programs and how they may benefit longer-term investors who want to build a position in a company.
  6. Investing News

    Understanding How Mutual Funds Pay Dividends

    The process by which mutual fund dividends are calculated, distributed and reported is fairly straightforward in most cases. Here's a look.
  7. Investing Basics

    Choosing Between Dollar-Cost And Value Averaging

    These are two investing practices that seek to counter our natural inclination toward market timing by canceling out some of the risk.
  8. Insurance

    Take Advantage Of Dollar-Cost Averaging

    We explain how dollar-cost averaging offers protection and opportunity in a sinking market.
  9. Retirement

    Dollar-Cost Averaging Pays

    Get the most out of your mutual fund by using this simple but powerful strategy.
  10. Investing Basics

    Are You Too Young To Care About Dividends?

    Find out why it's never too early to begin thinking about dividends and how dividend-bearing stocks and funds can grow your investment account effortlessly.
RELATED TERMS
  1. Distribution Reinvestment

    A process whereby the distribution from a limited partnership, ...
  2. Automatic Reinvestment Plan

    An investment program in which capital gains or other income ...
  3. Reinvestment Rate

    The amount of interest that can be earned when money is taken ...
  4. Total Return Index

    A type of equity index that tracks both the capital gains of ...
  5. Mutual Fund Yield

    Dividend payments divided by the value of a mutual fund’s shares. ...
  6. IRS Publication 564: Mutual Fund ...

    A document published by the Internal Revenue Service (IRS) that ...
RELATED FAQS
  1. What effect does a company's dividend reinvestment plan have on its stock price? ...

    When a dividend is received, an investor has two options: to keep the proceeds in a bank account or reinvest them. For the ... Read Answer >>
  2. Should mutual fund dividends be reinvested?

    Learn the advantages and disadvantages, as well as the tax impact, of having your mutual fund dividends automatically reinvested ... Read Answer >>
  3. How do I deal with stocks that pay dividend on a monthly basis?

    If I own 1,000 shares of company ABC, which yields $.50 per share. That would equal to $500. So, my qu... Read Answer >>
  4. How are dividends usually paid out?

    Discover the two compensation methods commonly used by companies and mutual funds to make dividend payments on equity investments. Read Answer >>
  5. What are the dividend reinvestment options for a mutual fund?

    Learn about the options that shareholders have for dividend distributions made by mutual funds and why a shareholder may ... Read Answer >>
  6. Do cash dividends that are no longer being reinvested affect the cost basis of my ...

Hot Definitions
  1. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  2. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  3. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  4. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  5. Sharing Economy

    An economic model in which individuals are able to borrow or rent assets owned by someone else.
  6. Unlevered Beta

    A type of metric that compares the risk of an unlevered company to the risk of the market. The unlevered beta is the beta ...
Trading Center