7 Ways to Reduce Your Investment Risk
By Akhil Chugh
Date December 12th, 2021
“Successful Investing is about managing risk, not avoiding it.”- Benjamin Graham, the father of value investing
Investing is a way to let your hard-earned money do some of the hard works for you. This sounds great on paper but in reality, investing comes with a degree of risk. Market returns can be outstanding in the long term, while in the short term their volatility can be terrifying. Risk is a constant companion to your investment portfolio that you need to take guard against to reach your financial goals. The key goal of your investment portfolio should be to minimize overall risk while simultaneously maximizing your investment returns.
Though it is not possible to completely eliminate all the risks there are various ways to reduce them. Here, we will discuss 7 actions that an investor can take to reduce the overall risk of an investment portfolio to help you ride choppy waters with ease.
Top 7 Ways to Reduce the Investment Risk:
1. Invest as per your risk tolerance:
Risk Tolerance refers to the amount of loss an investor is prepared to handle while making an investment decision Typically risk tolerance is determined by several factors like the age of the investor and his/her current financial obligations. For example, investors in their mid-20s who are unmarried have fewer financial responsibilities than investors in their late 50s who are married with college-going children. Thus, as a general rule, younger investors tend to be more risk-tolerant than older investors.
Knowing the risk tolerance level helps investors plan their entire investment portfolio and will drive how they invest. For example, if an individual’s risk tolerance is high, investments will be made more aggressively into more high risk & high return instruments like equity mutual funds compared to the individual with low-risk tolerance level who will be more conservative while making investments and will prefer low risk & low return instruments like debt funds.
So, if you start investing early in life, you can start your investment journey with a pure equity portfolio that is solely focused on aggressively growing your wealth. This strategy will definitely change if you are nearing retirement and need to focus on the preservation of wealth. By knowing your risk tolerance, you can figure out investments that deliver the best risk-return value to manage your overall portfolio risk.
2. Ensure sufficient liquidity in your investment portfolio:
A financial emergency can come anytime! The main risk to your investment portfolio is that due to a financial emergency you might need to redeem investments when markets are down. This risk can be significantly reduced by maintaining adequate liquidity. If we have liquid assets in our portfolio, then our existing investments can deliver optimal long-term returns and we will be able to benefit from any periodic market corrections.
One of the ways of maintaining sufficient liquidity in your portfolio is by setting aside an Emergency Fund that should be equal to 6 to 12 months of your expenses.
For ensuring that there is easy accessibility to emergency funds, we should have low-risk investment options like Liquid Funds, Overnight Funds and Arbitrage Funds in our portfolio. Once we have determined our risk tolerance and kept some money aside for ensuring adequate liquidity in our portfolio, then it is time to determine an asset allocation strategy that works for us.
3. Implement an asset allocation strategy:
Asset allocation means diversifying your total investments in the right proportions among different asset classes like equities, debt, bonds, and gold to maximize your overall return to achieve your financial goals while also trying to control investment risk.
Based on your age, financial situation, family and risk tolerance try to determine an asset allocation for yourself. This will help in determining how much exposure across each asset class you require to achieve your financial goals with minimal risk. At regular intervals, revisit your portfolio to check for any deviations from your initial asset allocation and take necessary actions.
4. Diversify your investments:
‘Don’t put all the eggs in one basket’ is a common investment mantra for successful investing.
Once we have decided on our perfect mix of asset classes for our portfolio, we can further reduce the overall investment risk by diversifying our investment within the same asset class. This means that if we are investing in Equity Mutual funds, then we should diversify within this asset class by investing in multiple Mutual Fund categories such as Large-Cap Funds, Mid Cap Funds, Small Cap Funds, Multi-Cap Funds, Flexi-Cap Funds, etc.
When the market crashes, the prices of small-cap stocks fall faster as compared to large-caps. So, by diversifying our portfolio, we will reduce the overall investment risk.
Go for fundamentally robust funds with a long-term track record. It’s prudent to invest in stocks and funds that have delivered consistent returns over the years. Also, study the underlying portfolio and ensure they are different.
Note over-diversification could be equally detrimental to the overall performance of your portfolio. Seek help from an expert team of Net Brokers to help you achieve optimum diversification aligned with your risk tolerance levels and financial goals.
5. Focus on ‘Time in the Market’ instead of ‘Timing the Market’:
‘Time’ and ‘Compounding’ are the two most powerful wealth-creating tools in the investment world. Instead of waiting for the right time to invest in the market, an investor should consider spending more time in the market by starting to invest early in the mutual funds via Systematic Investment Plan (SIP) mode of investment to benefit from the rupee cost averaging and power of compounding in the long run to create wealth.
Long-term wealth creation requires patience and disciplined investing. Contact Net Brokers to help you opt for SIPs in the right mutual funds aligned with your goals to ensure you get the benefit of disciplined investing while staying invested in the long term.
6. Review the portfolio periodically:
Stay invested for the long term for the compounding to show its magic but at the same time, don’t forget your investments completely. Periodic reviews can help to identify loopholes and plug them. Review your portfolio once in six months or in a year to monitor the performance of your investments. Closely analyse and weed out non-performers. However, before making any drastic change to your portfolio, review the cause of underperformance. Is it because of weak fundamentals or something else?
Note that when markets nosedived in March 2020, even fundamentally sound stocks took a beating. However, there was nothing intrinsically wrong with them. Most investors, however, panicked and pressed the exit button, turning notional losses into actual ones. So, you must guard yourself against such behaviour and undertake the review exercise carefully to make the most out of your investments.
7. Seek professional advice:
The portfolio is most risky when you haven’t done a proper market study and have only invested by word of mouth from your friends or relatives without a proper understanding of your financial goals & risk tolerance. The best way to reduce your investment risk is to hire a professional from Net Brokers to study your profile, risk tolerance and investment goals to suggest the right options for you to invest your money.
As every investment comes with some risk, it is impossible to create an investment portfolio that ensures Zero Risk. Having said that, following the above 7 ways can ensure that you will be able to find the appropriate balance between risk and return.
Key Takeaways from Net Brokers:
- No investment portfolio comes with zero risk. While you can’t get off it completely, you can minimise it by adopting the aforementioned ways. Optimum risk management can help you grow your wealth and achieve goals with ease.
- Chalk out your life goals and understand your risk tolerance levels before deciding on the right asset allocation for your portfolio. It will help you decide which mix will be beneficial for you in the short and long run.
- Opt for the SIP mode of investing for your mutual fund investments to benefit from rupee cost averaging and compounding.
- If you have an existing portfolio, don’t hesitate to revamp it if necessary. There is always time to make new and diversified investments.
- Getting professional advice from finance professionals of Net Brokers can help you chart out the right financial plan to fulfil your goals – and always remember to think with your head and not your heart!
Implementing the 7 ways mentioned above can definitely help you find the appropriate balance between risk and return so that your investments continue to grow over the long term and help you achieve your financial goals.
For more information, get in touch with us today! Download our mutual fund app & start investing for your long-term financial goals.
Happy investing!