Risk management entails considering the potential losses from different assets or stocks and finding ways to offset the risks of different holdings. To diminish single-class investment risk in the event of a downturn, we can capitalize on the low correlation among asset classes and sectors. We can also offset losses in one asset class or sector by gains in another. A simple example is when stocks are falling, bonds are usually positive.
If you look at websites that give you financial information, you can usually find the beta and the alpha. Beta measures the market risk and can be seen as a proxy of how a certain stock moves with market up- and downturns. When beta is 0, then the stock does not move with or against the market. When beta is positive, the greater the beta is, the more the stock moves like the rest of the market. When beta is negative, the more negative the beta, the more the stock moves the opposite of the rest of the market. Meanwhile, alpha measures the excess return of a stock when it is beating the market. Beating the market entails the so-called alpha risk.
One thing you can consider to diversify your portfolio is to invest in foreign stocks. The easiest way to do this is to invest in U.S. registered mutual funds or exchange-traded funds. Through this method you are able to avoid the costs of entering and doing transactions in foreign markets. These costs include transaction costs, foreign taxes, and currency conversions. If you choose to invest through American mutual funds or exchange traded funds, you are diversifying in more ways than one, through investing in different markets and through the variety of stocks that these ETF and mutual funds invest in. This does not mean that directly investing in foreign stocks does not have its benefits, but you should consider your level of expertise and the risks before delving deep into the unknown.
When you invest in foreign market you need to be aware of 4 types of risks that foreign stocks can add to your stocks:
Markets are sensitive to political turmoil and economic policy. In countries where governments opt for very different policies, there is corruption and depreciation of the currency, be wary of how these factors affect the market.
The U.S Securities and Exchange Commission (SEC) protects investors from fraudulent activity, but they mainly perform their duties in the United States and do not interfere with foreign governments.
The information and data available in foreign countries might be different from that of a publicly traded company in the U.S. and might not always be offered in English.
It might be more difficult to buy and sell stocks in a foreign market where financial markets are not as sophisticated.