All investors are faced by decision making task before they make any investment. They make use of technical analysis, gut feel and fundamental analysis while performing an investment analysis before they make their decision. These decisions are greatly influenced by the extant portfolio theory. This theory tries to minimize the risk and maximize on the returns by careful selection of assets. This theory has been has been in use in the financial industry and has yielded good results.
However, it has been criticized in the recent years by behavioral economics due to its assumptions (Shriller 2005). This theory advocates for diversification while investing. It aims at collecting investment assets whose value keeps fluctuating often. Therefore, the theory can only be applicable theoretically but not practically. This is because the theory assumes the investors are always rational and the markets are constantly efficient. It is in this respect that individual investors make their investment decisions practically without considering the theoretical aspect of it.
They consider the prospect of markets which are emerging and driven by a growth potential which must be very high to draw their attention. There are various factors that affect investment decisions and these should be taken into consideration before investing to minimize risk and to maximize the returns. Particularly while investing in a stock market investors ought to consider various aspects for instance, returns rate, inflation level, liquidity and return frequency (Mandelbrot et al 2006). Investment just like any other type of profitable business involves risks taking.
Some risks can be controlled and managed while others are beyond control. Stock markets are considered to be among the most risky businesses. There are various risks associated to the stock market. To begin with, economic risks whereby the economy fluctuates for instance, the US stock market in 2000 was very good but in 2001 following the September 11 terrorist attack the stock market declined drastically. This is a risk that is beyond control and therefore the investors should be ready for it in this kind of investment.
Another risk that stock market investors encounter is that of inflation. This risk mainly affects investors by eroding their income stream’s value especially those on fixed term incomes. Market value risk is also associated with the stock market. Fortunately, investors have various ways of managing their saving/ funds. Firstly, they get to identify the risks associated with the stock market and how to control or avoid them. They invest in a market’s trend thus preventing the likelihood of their stock falling when the market trend is rising.
Another strategy they employ is that of diversifying their portfolio across various companies, asset classes and sectors. This helps them to reduce the impact of any one company’s loss. They also base their stock position on their risk tolerance levels. This lowers their loss potential and increases their returns. In conclusion, risk management in stock market calls for the investor’s effort. The most successful stock investors employ all strategies of stock market risk (Shiller, 2005).