Benjamin P. answered • 07/11/18
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[Note that the main reason for this Answers section is to see how a particular tutor explains a subject. It's not intended to be a ready-made essay or homework help per se]
The central concept in investment risk minimization is diversification. It's the fancy term for the old saying, "Don't put all your eggs in one basket." If you drop that basket all of the eggs will break at once. That said, the questions that remain are how many baskets must you use and what is the nature of these vessels?
In the most general terms, it is safer to have two (entirely separate and legitimate) investments of $50,000 each than it is to have one of $100,000. How many times you must divide the total investment depends on your circumstances. Your age, health, net worth, current asset composition, lifestyle, future needs, and personal comfort level will define your advisable total investment, liquidity needs, and tolerable risk. From there, each type of investment carries its own risk and balancing those risks requires knowledge of inherent risk, market conditions, and trends.
As a simplified example, Mr. Farmer invested in a small-capitalization stock. He knew that it was inherently risky, so he also invested in gold, which he was told was safer. The above approach works to minimize risk in a rough manner. It will not meet all of Mr. Farmer’s needs. The scientific approach is to arrive at a numeric measure of overall tolerable risk and see if the individual risk numbers balance to the desired target. That's a taste of my course in risk management.
