Risk Management 101

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What You’ll Learn

• Why risk management is more important than picking stocks
• The #1 rule: Emergency fund before investing
• Position sizing: Never bet the farm
• Diversification: Don’t put all eggs in one basket
• Asset allocation by age and goals
• When to use stop-losses (and when not to)
• How to sleep well at night as an investor

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Why This Matters

• 😰 You’re afraid of losing all your money
• 🎯 You want to invest smartly, not recklessly
• 💤 You want to sleep well at night
• 📉 You’ve seen stories of people losing everything
• 🛡️ You want to protect yourself from disaster

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The Fundamental Truth About Risk

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Risk and Return Are Related

• Higher potential returns = higher risk
• Lower risk = lower potential returns
• Can’t eliminate risk entirely (or returns disappear)
• Goal is to manage risk, not avoid it

Low Risk,          Medium Risk,         High Risk,
Low Return         Medium Return        High Return

Savings            Index Funds          Individual Stocks
Account            (VOO, VTI)          (Apple, Tesla)
0.5% return       10% return          -50% to +100% return

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The Two Types of Risk

• Can’t be eliminated
• Affects entire market
• Examples: Recession, pandemic, war, interest rates
• Managed by: Asset allocation (stocks vs bonds vs cash)

• CAN be eliminated
• Affects individual companies
• Examples: CEO quits, product fails, scandal
• Managed by: Diversification (own many companies, not one)

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Rule #1: Emergency Fund Before Investing

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Why This is Non-Negotiable

• Month 2: Car needs $2,000 repair
• You have no emergency fund
• You’re forced to sell stocks to pay for repair
• Stock market happened to be down 10% that month
• You sell at $9,000 → Lost$1,000 plus repair costs
• Forced selling at wrong time destroyed your wealth

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The Emergency Fund Rule

Monthly essential expenses: $_______
× 6 months = $_______
Current savings: $_______
Emergency fund gap: $_______

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Where to Keep Emergency Fund

• Current rates: 4-5% APY
• FDIC insured (safe)
• Instantly accessible
• No risk of loss

• Marcus by Goldman Sachs
• Ally Bank
• American Express Personal Savings
• Capital One 360

• ❌ Stocks (too volatile)
• ❌ Bonds (not liquid enough)
• ❌ Crypto (too risky)
• ❌ Under your mattress (earns nothing)

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Rule #2: Never Invest Money You Can’t Afford to Lose

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The Time Horizon Rule

• Stock market can be down for 1-3 years
• Need time to recover from downturns
• Short-term volatility is normal
• Long-term, market always trends up

• 100% high-yield savings
• Example: Rent, car repair, wedding in 6 months

• 80% savings, 20% bonds
• Example: House down payment in 2 years

• 50% savings, 30% bonds, 20% stocks
• Example: Car purchase in 4 years

• 80-100% stocks
• Example: Retirement in 30 years

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The Catastrophe Test

• ❌ Don’t invest it
• ✅ Keep it in high-yield savings

• ✅ Okay to invest
• ✅ You can handle the volatility

• $18,000 emergency fund → KEEP IN SAVINGS
• $2,000 extra → Okay to invest (losing it won’t destroy you)

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Rule #3: Position Sizing (Don’t Bet the Farm)

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The Rule of Maximum Position Size

• Any company can fail (even Apple, Amazon, Google)
• Bankruptcy = 100% loss
• Bad earnings = 30-50% drop overnight
• One position can’t destroy you if properly sized

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Position Sizing Examples

• $9,000 in Tesla (90% of portfolio)
• $1,000 in cash
• Tesla drops 50% → Portfolio drops to $5,500 (-45% total)
• Catastrophic loss from one position

• $1,000 in Apple (10%)
• $1,000 in Microsoft (10%)
• $1,000 in Amazon (10%)
• $7,000 in VOO index fund (70%)
• Even if Apple goes to $0 → Portfolio only down 10%
• Manageable risk

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The Beginner’s Position Sizing Strategy

• VOO (S&P 500) or VTI (Total Market)
• Instant diversification across 500-4,000 companies
• Impossible to lose everything (would require all U.S. companies to fail)

• No more than 5% per stock
• So 4-6 different stocks max
• Only stocks you research and understand

• $7,000 in VOO (70%)
• $500 in Apple (5%)
• $500 in Microsoft (5%)
• $500 in Disney (5%)
• $500 in Nike (5%)
• $1,000 cash (10%)

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Rule #4: Diversification (The Only Free Lunch)

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Why Diversify?

• Tesla drops 50% → Portfolio drops 50%
• Catastrophic

• Tesla drops 50% → Portfolio drops 5%
• Manageable

• One stock drops 50% → Portfolio drops 0.1%
• Barely noticeable

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Types of Diversification

• Own 10-20+ different stocks
• Or use index funds (instant diversification across hundreds)

• Technology (Apple, Microsoft)
• Healthcare (Johnson & Johnson, Pfizer)
• Finance (JPMorgan, Visa)
• Consumer (Coca-Cola, Nike)
• Energy (Exxon, Chevron)

• Stocks (growth)
• Bonds (stability)
• Cash (safety)
• Real estate (optional)

• U.S. stocks (60-70%)
• International developed (20-30%) - Europe, Japan, Canada
• Emerging markets (10-20%) - China, India, Brazil

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The Lazy Portfolio (Perfect Diversification)

• 100% in VT (Vanguard Total World Stock ETF)
• Owns 9,000+ stocks worldwide
• Instant global diversification
• Set it and forget it

• 60% VTI (Total U.S. Stock Market)
• 30% VXUS (Total International Stock Market)
• 10% BND (Total U.S. Bond Market)
• Globally diversified across stocks and bonds

• Example: Vanguard Target Retirement 2060
• Automatically diversified and rebalanced
• Becomes more conservative as you age
• True set-it-and-forget-it

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Rule #5: Asset Allocation (Stocks vs Bonds vs Cash)

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What Is Asset Allocation?

• Stocks (high risk, high return)
• Bonds (low risk, low return)
• Cash (no risk, minimal return)

• More important than which stocks to pick
• Determines 90% of your returns and risk
• Changes based on age and goals

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Asset Allocation by Age

• 110 - 25 = 85% stocks
• 15% bonds/cash
• Aggressive growth (long time horizon)

• 110 - 40 = 70% stocks
• 30% bonds/cash
• Moderate growth

• 110 - 60 = 50% stocks
• 50% bonds/cash
• Conservative (nearing retirement)

• 110 - 75 = 35% stocks
• 65% bonds/cash
• Capital preservation

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Asset Allocation by Time Horizon

• 40% stocks
• 40% bonds
• 20% cash

• 70% stocks
• 25% bonds
• 5% cash

• 90-100% stocks
• 0-10% bonds
• 0% cash

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Sample Portfolios

90% stocks:
  - 63% VOO (S&P 500)
  - 27% VXUS (International)
10% BND (Bonds)

70% stocks:
  - 49% VOO
  - 21% VXUS
30% bonds:
  - 25% BND
  - 5% cash

50% stocks:
  - 35% VOO
  - 15% VXUS
50% bonds:
  - 40% BND
  - 10% cash

30% stocks:
  - 21% VOO
  - 9% VXUS
70% bonds/cash:
  - 50% BND
  - 20% cash

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Rule #6: Rebalancing (Maintain Your Allocation)

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Why Rebalance?

• 80% stocks ($8,000)
• 20% bonds ($2,000)

• Stocks: $9,600 (85% of portfolio)
• Bonds: $2,100 (15% of portfolio)
• Total: $11,700

• More risk than intended
• Drifted from plan

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How to Rebalance

• Stocks: 85% (target: 80%)
• Bonds: 15% (target: 20%)

• Sell $585 of stocks
• Buy $585 of bonds
• Back to 80/20

• Instead of selling, direct new money to underweight assets
• Adding $1,000 new money? Put it all in bonds until back to 80/20

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Rebalancing Frequency

• Less trading = lower taxes and fees
• Annual is enough to stay on track

• More work
• Potentially more taxes

• Drift too far from plan
• Take on unintended risk

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Rule #7: Stop-Losses (When and When NOT to Use)

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What Are Stop-Losses?

• Buy Tesla at $250
• Set stop-loss at $225 (10% below)
• If Tesla drops to $225, auto-sells
• Limits loss to 10%

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When to Use Stop-Losses

• Day trading or swing trading
• Need automatic protection
• Can’t watch market constantly

• Risky individual stocks
• Small cap or penny stocks
• Positions you’re not confident holding long-term

• Bought at $100, now$150
• Set stop at $135 (locks in at least$35 profit)
• Called a “trailing stop-loss”

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When NOT to Use Stop-Losses

• Buy-and-hold strategy
• Stop-loss defeats the purpose
• Market volatility will trigger it prematurely

• March 2020 COVID crash: Market dropped 35%
• Stop-losses triggered at $200
• Market recovered to $300 by end of year
• Stop-loss sold at worst price, missed recovery

• Long-term holds
• Expect volatility
• Don’t want to be stopped out

• Hold for dividends, not price
• Short-term price fluctuations don’t matter
• Stop-loss inappropriate

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Alternatives to Stop-Losses for Long-Term Investors

• No more than 5-10% per position
• Can tolerate 50% drop without catastrophe

• Own many positions
• One position dropping doesn’t destroy portfolio

• Never forced to sell
• Can hold through downturns

• Commit to holding through volatility
• Don’t panic sell
• Trust the process

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Rule #8: The Sequence of Safety

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Build Your Financial Foundation

• 3-6 months expenses in savings
• Non-negotiable foundation
• Must complete before investing

• Credit cards (15-25% APY)
• Payday loans
• Any debt over 8% interest
• Why: Can’t beat 20% credit card interest by investing in 10% stock market

• 401(k) employer match is free money
• Contribute at least enough to get full match
• Example: If employer matches 5%, contribute 5%

• Now start regular investing
• Index funds for core
• Individual stocks for learning (small %)

• Max out 401(k): $23,000/year (2024)
• Max out IRA: $7,000/year (2024)
• Tax advantages + compound growth

• Taxable brokerage account
• Real estate (optional)
• Alternative investments (optional)

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Common Risk Management Mistakes

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Mistake #1: No Emergency Fund

• Invest all $15,000 savings
• Car breaks down, need $3,000
• Forced to sell stocks (at a loss) to pay for repair
• Lost money + lost position

• Keep 6 months expenses in savings FIRST
• Then invest surplus

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Mistake #2: Too Concentrated

• $20,000 portfolio
• $18,000 in Tesla (90%)
• $2,000 in cash
• Tesla drops 50%
• Portfolio drops 45% due to one position

• No more than 5-10% per position
• Use index funds for core holdings

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Mistake #3: Wrong Time Horizon

• Need $10,000 for house down payment in 1 year
• Invest it all in stocks
• Market drops 20%
• Now have $8,000, can’t buy house
• Wrong investment for time horizon

• Money needed within 3 years → savings or bonds
• Money for 5+ years → stocks

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Mistake #4: Panic Selling

• Market drops 10% in one week
• Fear takes over
• Sell everything “to protect what’s left”
• Market recovers 15% over next month
• Sold at bottom, missed recovery

• Don’t check portfolio daily
• Trust your plan
• Market drops are normal and temporary

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Mistake #5: No Plan

• “I’ll just wing it and see what happens”
• No allocation strategy
• No position sizing rules
• No sell discipline
• Chaos and losses

• Write investment policy statement
• “I will invest $X/month in 80/20 stocks/bonds until retirement”
• Follow plan regardless of emotions

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Creating Your Personal Risk Management Plan

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Template: Your Investment Policy Statement

• I need this money in: ___ years
• Target date: ____

• I can tolerate losses of: __ % without panicking
• Maximum acceptable loss: $____

• ___ % stocks
• ___ % bonds
• ___ % cash

• Maximum per individual stock: __ %
• Maximum per sector: __ %
• Index funds: __ %

• Frequency: Annually / Quarterly / Other
• Trigger: When allocation drifts __ % from target

• If portfolio drops 20%: Hold / Buy more / Rebalance
• If I lose job: Stop investing / Use emergency fund
• If I need money urgently: Sell ___ first (cash, then bonds, then stocks)

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Example: Beginner’s Risk Management Plan

• 85% stocks (long time horizon)
• 10% bonds
• 5% cash

• 70% in VOO (S&P 500 index fund)
• No more than 5% in any single stock
• Maximum 6 individual stocks (30% total)

• If market drops 20%: BUY MORE if I have extra cash
• Keep 6 months expenses ($18,000) in savings always
• Never sell stocks to pay for expenses (use emergency fund)

• Invest $500/month automatically
• 80% to VOO, 20% to bonds
• Never check portfolio except monthly review

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Success Checklist

• ✅ I have 3-6 months expenses in emergency fund
• ✅ I’m only investing money I won’t need for 5+ years
• ✅ I can afford to lose 30-50% without life impact
• ✅ I have high-interest debt (>8%) paid off

• ✅ No more than 5-10% of portfolio in single stock
• ✅ I’m diversified across at least 10 holdings (or use index funds)
• ✅ My asset allocation matches my age and goals
• ✅ I have a written investment plan
• ✅ I’ll rebalance annually

• ✅ I won’t panic sell during market drops
• ✅ I won’t check portfolio daily
• ✅ I won’t chase hot stocks with large positions
• ✅ I’ll stick to my plan for decades
• ✅ I’ll sleep well at night

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What’s Next?

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Continue Your Education

• Power of Compound Interest →
• Understanding Volatility and Emotions →
• Common Beginner Mistakes →

• Your First $100 in ETFs →
• Build a Diversified Portfolio →

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Ask Money Monty for Your Risk Plan

I'm [age] with $[amount] to invest. I need this money in [X] years.
Help me create a risk management plan. What should my asset
allocation be? How should I size positions?

• Recommend appropriate asset allocation
• Suggest position sizing rules
• Create diversification strategy
• Help you build investment policy statement
• Ensure you’re protected from catastrophic losses

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The Bottom Line

• ✅ More important than picking stocks
• ✅ The difference between retiring wealthy and going broke
• ✅ How you sleep well at night
• ✅ Boring but essential

1. Emergency fund before investing (3-6 months expenses)
2. Never invest money you can’t afford to lose
3. Position sizing: 5-10% max per stock
4. Diversification: Own 10-20+ stocks or use index funds
5. Asset allocation: Stocks/bonds/cash based on age and goals
6. Rebalance annually
7. Stop-losses only for short-term trades, not long-term holds
8. Follow a written plan