If you want to make big money, you'll probably have to take big risks, but there are ways to make sure your payoff is worth the danger. Here's how to be smart about it.
By Annie Logue, MSN Money
Wanna get rich quick?
If you want a high return, you'll have to accept a high degree of risk.
Maybe you're in the lucky position of making a little more money than you need to live on. Or maybe you've just received some cash you're not planning to spend for a long time, allowing you to stomach the ups and downs of, say, a tech investment.
In either case, putting a portion of your resources into a high-risk investment may make sense. Just make sure you're ready for the downside as well as the upside.
If you want to take on risk, we have seven strategies for you to consider:
1) Concentrate.
Diversification is great because it reduces risk. But at some point, you might want to build on your nicely diversified core with a big chunk of risk concentrated in one sector.
"If you're looking to do better than the average return, the only way is to reduce your diversification," says Jordan Kimmel, author of Magnet Investing and president of Magnet Investment Group in Randolph, N.J.
Concentration will increase your risk, and Kimmel says that's good, in the right circumstances.
Who should be "non-diversified"?
According to Jordan Kimmel, average investors may not be in a postion to diversified, a fact is the harzards of being concentrated in wrong existed. So, he suggested that in the beginning, inexperience investors should invest in small bats of diversification as you go off to gain experience. That will help less and less concentrated in wrong.
"You have to be willing to accept short-term volatility as the prerequisite for making money," he says. "The investments that have the smallest volatility also have the smallest end returns."
2) Leverage up.
One quick way to increase your risk and your potential return (as well as your downside) is to borrow money for your investment, usually through a margin account at a brokerage firm.
Tim Phillips of Phillips & Co., a wealth-management firm in Portland, Ore., suggests that moderate leverage is a way for clients to enhance their returns. But they need to be careful.
It's true that leverage can generate a return on money you don't have, but it generates an outsized risk as well. Pay attention now, get-rich-quick fans: Users of margin loans need to be keenly aware that a drop in the value of an investment can result in a margin call, requiring additional capital. Investors who can't pay can be wiped out.
3) Hunt for bargains.
As Chicago Cubs fans know, loving the underdog can be painful, but sometimes it pays off big. (Maybe this year? Nah.) That's why Phillips recommends that investors consider distressed securities, such as bonds issued by companies near bankruptcy or, right now, stocks in banks that have heavy real-estate exposure.
"We try to find counterintuitive opportunities that take advantage of extreme emotional responses," he says.
This is risky because sometimes an investment is cheap for a reason. But if the low price is a function of feelings instead of fundamentals, the payoff can be huge.
4) Be above brands.
Many investors feel safest with something they know. But just because you have never heard of something doesn't make it a bad investment. Kimmel recommends that investors screen for companies that are growing revenues by 20% or more each year while increasing profit margins by 5% or more.
Only a handful of companies will fit these criteria at any one time, he says, and they probably won't come up in cocktail party chatter.
"You've got to be willing to own companies that are less known," Kimmel says. The underlying profitability gives you more cushion than any brand name ever could. Are you looking to make conversation or money?
5) Explore emerging markets.
It's a big world out there, and much of it is growing faster than the United States.
"All the demographics point to opportunities in six countries: Brazil, Russia, India, China, Mexico and South Korea," says Pran Tiku, the president of Peak Financial Management in Waltham, Mass.
There will be risk in all these markets as their citizens feel their way into modern economies, but Tiku says it's worth it.
"If investors are focused on long-term growth for their portfolios, they must invest in developing markets," he says.
He recommends that investors use exchange-traded funds or buy stock in the largest companies in each market, usually available as American Depositary Receipts traded on the New York Stock Exchange.
2 critical things to know about ADR prices
According Anthony Moro, Bank of New York Mellon, Vice President;
1) underline currency rate vs. US dollar and 2) ratio of ADR vs. ordinary shares.
6) Consider commodities.
In a world economy that is growing rapidly, demand for commodities -- such as oil, cotton and corn -- is bound to grow. As demand grows, prices of commodities are likely to rise.
Individual investors can get exposure to growing global demand for commodities through commodity-based exchange-traded funds.
"India and China are going to be consuming nations," Tiku says. He speaks of massive infrastructure projects in developing countries and the spread of affluence among peoples long mired in poverty.
"It all points to huge growth," he says.
All of this relates to long-term trends. Commodities prices can be volatile in the short term because of unpredictable weather patterns, swings in growth projections and emotional trading on futures exchanges. Investors in long-term trends need to be patient enough to ride out the bumps along the way.
7) Do your research.
The more risk you want to take, the more work you'll have to do. When you do good research, you'll find more opportunities to add risk -- and return -- to your portfolio. The advice of steel tycoon Andrew Carnegie was that it's OK to put all your eggs in one basket, as long as you watch the basket pretty carefully.
Key to watching your portfolio
Take your ego out of your investment and understand the investments take time to grow.
Watching the basket can be great fun, if you're into it. And if you're not? Phillips suggests those folks find money managers who can do the research and choose the investments for them.
One other point: If your portfolio doesn't already have such risky assets as distressed securities, emerging markets or commodities, adding these to your portfolio in a balanced way can actually reduce your risk while increasing your return, thanks to the magic of diversification.
Here's an example. Say most of your money is in U.S. Treasury bonds, a very conservative investment. The only real risk there is the possibility that inflation or a drop in the value of the dollar (events that might occur in tandem) will undermine the value of the cash stream from the bonds.
Now say you take 15% of that money and buy stock in a handful of high-growth companies in Europe and Asia. Has your total risk gone up or down?
Most investment professionals would say it has gone down, while your likely return has gone up.
Published June 23, 2008
Article from MSN Money
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