Ways to reduce investment risk in your portfolio
The motive of achieving financial goals is to determine the investment ways through which the goals may be achieved by taking minimum risks.
The motive of achieving financial goals is to determine the investment ways through which the goals may be achieved by taking minimum risks. But to create wealth or to achieve financial goals with limited resources, one has to take some risks and invest in instruments having capital risks.
However, there are ways to reduce the risks through diversification, investing throughout the market cycles, etc.
“Any investment, big or small, is subject to market risks. The thumb rule to thus, remember is to protect your principal. While risks cannot entirely be predicted or avoided, one can possibly protect the portfolio by being mindful, careful, and observant of market changes in order to reduce investment risks. Diversification helps, in more ways than one. Investing in more than one asset class will ensure a reduction in unsystematic (investing in one particular company) risks because if/when you encounter a loss, the loss is limited,” said Anil Pinapala, CEO & Founder of Vivifi India Finance.
“What you add to your portfolio matters. If you add a number of non-correlating assets, it will ensure a balanced return because you will always have an asset to fall back on in times when one of your chosen investment assets sees a fall, owing to changes in the market. This thus smoothens out the volatility of your portfolio. However, be mindful of over-diversification,” he added.
Despite the need of adding risky investment instruments to a portfolio to achieve financial goals, the risk appetite and risk-taking capacity of an individual also impact the choice of instruments.
“How you invest and what you choose to invest in depends on risks you are willing to or are capable of taking. No two individuals will have the same risk appetite. It is therefore important to identify yours, taking into consideration factors like age, earnings, responsibilities (dependants), and your financial goals,” said Pinapala.
“It is advisable to maintain adequate liquidity and seek financial advice before investing, keeping in mind these points. But once you invest, your job isn’t done, it has only begun because to reduce risks on your portfolio, it’s crucial to understand the market, watch out for any changes that may/may not affect your portfolio, evaluate your investments and rework your asset allocation if need be,” he added.
Explaining the relationship between risk and returns, Alok Kumar, Founder & CEO, StockDaddy, said, “There can be only four different scenarios when you invest money in any of the stock or any financial asset – Big Loss, Small Loss, Big Profit, Small Profit. Now, what do you think can drastically impact your returns? Yes, it’s a Big Loss (Say 10-15 percent in a single trade or 15-30 percent in a single investment). So we must ensure not to fall prey to such poor risk management practices. Instead, risks must be defined before taking the trades and they should be rigidly defined as per a fixed percentage of your capital.”
“Once you are aware of the money you afford to lose on a particular stock, you must define the quantity you can buy. Finally, don’t put all the eggs in a single basket. You must diversify the portfolio sector-wise and market cap-wise,” he added.
Explaining the importance of analyzing the risks before selecting an investment avenue, Nitin Mathur, CEO, Tavaga Advisory Services, said, “Risk is one of the most underrated subjects in the world of financial markets, however, every time there’s a decision to take concerning an investment, the first thought in an investor’s mind should be around the risks involved in a trade.”
Mathur suggests the following basic principles for risk reduction:
- Ensure that the portfolio is diversified enough. Diversification means spreading out investments across various sectors and not sticking to a particular theme or idea. While over-diversification leads to fewer returns along with low risks, a concentrated portfolio is a high-risk-high-return concept only advisable to those who are experts in this field. The investor’s job is to find the middle ground (between over-diversification and concentration).
- Buy value and buy cheap. The best part about value investing is that it offers the maximum margin of safety as the downside is limited unlike growth investing where uncertainties are high and the downside is huge. Will you consider buying a real estate property at a high price when there are other cheap options available? The same is the case with stocks and mutual funds. Find themes that are available at cheap prices and undergoing temporary downturns but are expected to do well in the future.
- Maintain a disciplined approach towards mutual fund SIPs irrespective of what is happening in the world. Systematic Investment Planning (SIP) helps in averaging out the NAVs at various levels in the long run. Always prefer SIPs over lump-sum investments, be it stocks or mutual funds.
- Avoid taking leverage and adding stocks with the help of margins. Pure cash investing is a slow and steady process to win the race. While it takes time, the investor doesn’t have to worry about any repayments.