Investment risk is defined as the probability or likelihood of the occurrence of losses as compared to the expected return from an investment. All investments carry a certain level of risk, be it equities, MFs, bonds, or investments in gold.
The idea here is not to erase the risk completely but to reduce it to a degree where it does not hurt the overall portfolio and safeguards it from capital erosion.
Let us go through some strategies that will help you to design an optimum portfolio to reduce the risk factor in your investments.
6 Strategies To Reduce Investment Risks:
1. Understanding your risk appetite
The first and foremost step before making any kind of investment is to understand your own risk appetite. This may depend on your age, income, near-term and future goals, beliefs, knowledge, and experience. The thumb rule for investments says that a person can invest (100- age) into equities and rest into debt.
Therefore, if you are at a younger age with less number of dependents you can invest the majority of your investible surplus into equities and the rest into lower-risk debt instruments and keep shifting from equity to debt slowly and gradually as your age increases.
Let your risk appetite determine your investment approach and choice of products.
2. Asset Allocation
Depending on your risk appetite, now start allocating your investments across the mix of asset classes with varying levels of risk-return tradeoffs. This might not always guarantee you a higher return but reduce the probability of wealth erosion.
Let us understand the risk-return trade-offs of some basic instruments.
Equity Investments:
Equity as an asset class is known to be the riskiest over the short term due to the day-to-day volatility in the markets. Over a longer period, it gives a higher return as well when the short-term fluctuations and inflation are taken care of.
Bonds:
Bonds are relatively safer when compared to equity investments because of the less severe short-term price movements. However, over the long term, the returns might not be very attractive as the returns are lower and are not able to beat inflation.
Money Market:
Money market instruments are considered the most stable of the three but are not able to beat inflation by a very big margin in the longer run.
Another strategy here could be to invest in assets that are negatively or less correlated to each other. The idea here would be to invest in asset classes with different behavior toward systematic market risk and to hedge against any negative impact that your overall portfolio might have.
In such situations when a recession hits, many asset classes might lose their value, but the others could compensate for the loss.
3. Diversification In Investing
The idea of diversification is as good as the old age saying, “Don’t put all your eggs in the same basket”. This simply means that within each asset class as well there should be enough diversification done.
For example, when investing in equities, make sure you are not limiting your investments to any particular company or sector. Rather create a proper mix of investments into large, mid, and small-cap companies across high-growth and stable sectors.
4. Make Systematic Investment Plans
“Be fearful when others are greedy and be greedy only when others are fearful.” – Warren Buffet
This simply means entering the market when the stock prices are low and exiting when the prices are high. This might however not be possible for a lot of us. So instead, one can keep a certain amount aside every month for investments in the equity markets.
This will help you deal with the volatility. You will be able to buy more units in a bear market and vice-versa helping you to average out your buying price per unit.
5. Restrict yourself from temptation and do your own research
In today’s world, it is very easy to get tempted into investments that a large number of retail investors are doing for example the new and upcoming IPOs. Always understand that a rally in the market is followed by corrections, which in turn brings down the price of overvalued stocks.
So before you make any investments make sure you do proper research. Try to understand the company’s business model, and management history and study the price movement. It is always suggested to seek advice from a financial advisor before jumping to any conclusions and making investments hastily or because of hearsay.
6. Periodic Investment Analysis
It is very important to check the health of your investment portfolio at regular intervals. For long-term investors, this can be done on a quarterly basis. Track the performance of the individual holdings and understand the reason behind their good/ bad performance. Do not hesitate to re-balance your portfolio occasionally. It is always better to exit the poor performers in your portfolio rather than letting them weigh your whole portfolio down.
Keeping these simple yet important things in mind, you can start investing by creating a basic investment portfolio for yourself. You can always take the help and advice of experts before making any big commitments.
Note: Before making any investments, always make sure that you keep an amount equivalent to 5-8 months of your expenses liquid as an emergency fund. This will help you in case of any uncertainties and reduce the risk of liquidating money at lower valuations from your investments.
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