Reduce your Portfolio Risk

Sometimes, investors focus only on how much money they anticipate they will make in their portfolio that they forget about protecting what they already have. As an investor, your number one priority should be to protect your capital, once that's sorted out you can focus on putting your money to work for you.

Protecting your property or privacy is a natural instinct. There are many ways we protect our property, but something very few people do is protect the value of their portfolio. We deposit our money in the bank or in a safe deposit box, without a second thought as to how inflation, market and currency risks will impact on its value.

Market risk is a risk you take when you invest in the market. If the market you have invested in (stocks, real estate, bonds etc.) crashes, the value of your investment will drop. This risk can be minimized by diversifying your money in different markets, this way you reduce the exposure of your portfolio to any one market. If one or two markets experience a decline, the value of your portfolio will suffer less.

Inflation risk is another risk the value of your portfolio faces. Inflation erodes the buying power of your money. As inflation continues year by year, every $1 you own will be worth less and less, reducing the value of your savings and investments. If you have invested conservatively and have a large percentage of your capital in bank accounts, CDs and bonds, even though it will appear that you are earning money, with the effect of inflation you may actually be losing money.

Inflation and interest rates affect the Forex market in a fairly predictable way. If one countries interest rate less inflation is higher than another's there's a pretty good chance the value of the currency in that country is going to go up. This occurs as international investors seek to invest their funds where it can gain the most, placing increasing demand on the currency which pushes the value up. You can use this predictable pattern to make money in the Forex market.

Most investors choose a variety of investments from their home country for their portfolio. This makes sense, after all, investing in a market you know little about can add additional risk. There will also be a lot more information available for markets close to home than further away, and the availability of relevant timely information is very important for decision making. The end result however can be that your entire investment portfolio will be invested in a certain currency, if your home country is the U.S most of your investments (the stock market, bonds, real estate) are probably in U.S dollars.

The disadvantage of this is that your portfolio is also exposed to currency risk, if the value of the U.S. dollar goes down, the value of your portfolio also declines. If your home currency is worth less, the price of imported products will go up and your buying power for an international holiday will also be less. You can minimize your exposure to currency fluctuations by taking out a hedge in the Forex market.