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Investment Risks? Who isn’t afraid of investing in financial assets due to the element of “risk” in it? You must have surely heard about Benjamin Graham, the father of value investing. He said- “Successful Investing is about managing risk, not avoiding it.”
Yes! We cannot totally avoid investment risk but we can definitely reduce it by managing risk effectively. Now you must be wondering how we should manage risk? Well, as we always say, worry not! We are here to help you understand these terms and further financial literacy!
When we are seeking success in our investments, managing risk doesn’t mean totally avoiding it. Have you heard the phrase?- “No risk no return, go high to get more!” There is always going to exist some element of risk but we shall guide you to manage them efficiently!
So, diversification of risk helps us in bringing prospects for higher returns that help us in our wealth creation. When we are investing in riskier investment tools, we need to adopt investment risk management strategies for reducing losses and investment risk. So, in this week’s blog, we will discuss 8 Strategies to Reduce Investment Risks.
8 Strategies to Reduce Investment Risks:
1. Understand your Risk Tolerance:
Risk Tolerance refers to the ability of an investor to endure the risk of losing their capital i.e. invested. Risk tolerance mainly depends on the investor’s age and current financial obligations. For example, if you are in your mid-20s, unmarried and have fewer financial responsibilities then you are more risk-tolerant compared to the other investors who are in their late 50s and are married with college-going children. So as the general rule, younger investors are more risk-tolerant than older investors.
So, if we start investing early in life then we can begin our investment journey with an investment portfolio having pure equity that is mainly focused on aggressive wealth creation.
But one should note that this strategy is not recommended for those who are about to retire and they need to focus on wealth preservation. By knowing what is our risk tolerance, we can figure out investments according to the best risk-return value for managing our investment risk.
2. Keep Sufficient Liquidity in your Portfolio:
Beware! A financial emergency can come anytime! So, we need to redeem our investments anytime even when the markets are down. This risk can be reduced if we maintain 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 8 months’ expenses. For ensuring that there is easy accessibility to emergency funds, we should have low-risk investment options like Liquid Funds and Overnight Funds in our accounts. 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.
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3. The Asset Allocation Strategy:
Asset Allocation refers to investing in more than one asset class for reducing the investment risks and this strategy also provides us with optimal returns. We can invest in a perfect mix of key asset classes like Equity, Debt, Mutual Funds, Real Estate, Gold etc.
One of the asset allocation strategies is to invest in a combination of asset classes that are inversely correlated to each other. For example, when one asset class is outperforming then the other asset class underperforms such as Equity and Gold. Equity and Gold are inversely correlated to each other, so when equity outperforms, gold underperforms.
4. Diversify, Diversify and Diversify:
After we have found our perfect mix of asset classes for our portfolio, we can further reduce the overall investment risk by diversifying our investment in the same asset class. This means that if we are investing in Equity Mutual funds, then we should diversify in this asset class by investing in large, middle or small-cap equity mutual funds.
When the market crashes, the prices of small-cap companies fall faster as compared to large-cap companies. So, by diversifying our portfolio, we will reduce the overall investment risk.
5. Instead of Timing the Market, Focus on Time in the Market:
Rather than making a quick buy by timing the market, we should focus on staying for a longer time in the market. Only then can we take the benefit of compounding. If we are invested for a longer time in the stock market, then the smaller corrections won’t affect our portfolio and will reduce the overall investment risk.
6. Do your Due Diligence:
Always do your due diligence, before investing in any type of investment tool as you are responsible for your finances. For example, if you are buying a stock for long term investment purposes then you must check how the management is performing and certain key ratios suck Debt-Equity ratio, PE, etc. By doing fundamental analysis we will get an idea of how the company will perform in the upcoming years. If we blindly invest in the stocks by listening to the recommendations of others then we might suffer the loss that will increase our investment risk.
7. Invest in Blue-Chip Stocks:
To avoid liquidity risk, it is always better to stay invested in a blue-chip stock or fund. Investors should check the credit rating of debt securities to avoid default risk.
Remember that all types of investment products have some other risks. As we have discussed earlier one should consider their risk appetite before deciding on any investment. One should be careful that investment decisions should not affect their lifestyle.
8. Monitor Regularly:
After considering all the factors above, one should monitor their portfolio regularly. If you are a long-term investor, that doesn’t mean that you invest and forget about your portfolio. You need to regularly keep a watch on your portfolio’s performance and do periodic reviews.
Portfolio review should be done once in six months, that’s because some asset classes like equities are prone to short-term volatility, as a long-term investor you should overlook short-term volatility and only change when your investments show poor performance over an extended period.
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As every investment has some risk, it is impossible to create an investment portfolio that ensures Zero Risk. That said, implementing the above 8 strategies as discussed above we can ensure you that you will be able to find the appropriate balance between risk and return.
This will let your investments continue to grow and help you to achieve your financial goals. As we said at the beginning of our blog “Successful Investing is about managing risk, not avoiding it.” We hope you found this blog informative and use the information to its max potential in the practical world. Show some love by sharing this blog with your family and friends and help us in our mission of spreading financial literacy.
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