Keep Risk At Bay
Hemant Rustagi
Chief Executive Officer, Wiseinvest Pvt Ltd.
Every investor aspires to achieve investment objectives without getting exposed to undue risks. While the right mix of asset classes, investment philosophies and a well-balanced exposure to different segments of the stocks markets helps in reducing the overall portfolio risk, the key is also to consider your risk tolerance around your investment goals. Here’s how you can cut risks in your investment process and strike the right balance between risk and reward.
1) Determine your risk tolerance. : While the path to investment success is well-defined, investors often follow strategies that expose them to higher risks and that too without guaranteeing higher returns. Therefore, as an investor, you must understand the right meaning of risk. For example, when you invest in mutual funds, the risk refers to the impact of market fluctuations on the NAVs of funds in your portfolio. Clearly, the impact of volatility is more in short and medium term and not so much over the longer term. Hence, don’t deviate from your asset allocation during turbulent times and continue to keep your focus on your varied investment goals.
Remember, your capacity to take risk emanates mainly from your time horizon. That’s why it is crucial to have a clearly defined time horizon as that would allow you to have an ideal asset allocation in place. Asset allocation not only reflects the kind of risks you are taking but also the return you can expect over time. For example, while investing for long-term, the aim should be to stay ahead of inflation and that can be achieved only by investing in asset class like equity. However, considering that equity markets have a tendency to turn volatile from time to time, a clear understanding of time on hand makes it possible for you to stay invested.
2) Diversify your portfolio adequately. A diversified portfolio minimises the overall risk associated with your investments. Owning investments across different funds ensures that industry-specific and company-specific risks are low. However, investors often make the mistake of having too many funds in their portfolios, presumably to achieve a higher level of diversification. However, they forget that mutual funds themselves are a diversified investment vehicle and hence having too many funds can be counter-productive.
Over-diversification usually results in a portfolio consisting of good as well as poorly-performing funds. Needless to say, non-performing funds pull down the overall portfolio return. If you are faced with such a situation, you must take stock of the portfolio mix and take steps to weed out non-performing funds as well as realign the portfolio in a manner that funds investing in aggressive segments such as mid-cap and small-cap do not take you beyond your risk-taking capacity.
3) Don’t allow short-term market movements to influence your investment decisions. While it is natural to get affected by the short-term performance of the market, it is vital not to allow it to influence your investment strategy. For example, abandoning equity funds during market downturns can be detrimental to the long-term prospects of your investment portfolio. Remember, negative returns during certain periods do not necessarily mean poor performance. Similarly, investing aggressively in an asset class like equity based on short-term performance can take you beyond your defined risk levels. Remember, even a usually poorly performing fund can give decent returns when the markets are doing well. Besides, a fund manager can give impressive returns by exposing investors to higher risk than their accepted level.
Therefore, the right way to remain unaffected by short-term market trends is to follow a disciplined investment process wherein investments are aligned to investment goals with a clearly defined time horizon. The most important factor is to participate actively in your investment process. There is no doubt about the fact that you can benefit immensely from the guidance of professionals in building your portfolio as well as keeping it on track to achieve your investment goals. However, you must participate in the decision-making process actively as any change in your requirements or personal situation over time may need a change either in the strategy or asset allocation. Besides, being actively involved in the process will help you in having the right mindset which is a critical factor in the kind of investment you can achieve over time.