Scott Rothbort
Recently, I discussed the concept of risk. Now that you understand the main forms of risk that you might encounter, I want to take the discussion one step further and focus on risk management. Risk management is the process by which risk is identified, quantified, and controlled (as much as possible).
Get Organized and Identify Your Risks Risk management starts by identifying the risks that are embedded in individual holdings and at the portfolio
level. This starts by having a good accounting and organization system for your holdings. I suggest developing a database that allows you to organize, query and manipulate data in an expedient manner. Make sure that this database separates or identifies your holdings by asset class . For example, have a field that indicates whether a holding is a stock , option , bond , preferred stock or other type of security. Include other fields for such information as position, rates, dividends , maturities and expirations . The more characteristics in the database for an individual security, the better your chance of identifying, quantifying and managing risk.
Once your database is on track, you'll need to develop a disciplined and proactive approach to populating and updating it. When you add a new asset or security to your portfolio, you should immediately update the database and recognize the risks inherent in holding that particular investment.
Quantify Your Risks
With a convenient database of your holdings, the next step is to quantify your risk. This can be done by first sorting the data into different asset classes, which typically have unique risks associated with their asset types. Then you can begin to apply some quantitative measures.
For example, you may want to calculate the market risk for your portfolio. Here is a question taken directly from an exam for my MBA students at Seton Hall University:
You own the following portfolio:
| Your Stock Portfolio | ||||||
| Stock | Shares | Price | Beta | Dividend | ||
| Caterpillar (CAT) | 10,000 | $74 | 1.05 | 2% | ||
| Google (GOOG) | 2,200 | $400 | 1.50 | 0% | ||
| Southern (SO) | 20,000 | $30 | 0.45 | 5% | ||
| Men's Wearhouse (MW) | $7,000 | $40 | 0.90 | 1% | ||
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