Reduce Risk & Improve Return

Hemant Rustagi, Chief Executive Officer, Wiseinvest Advisors

Many of us expect supernormal returns from our investments at all times. While there is nothing wrong in expecting the best while investing our hard-earned money, the problem arises when we hope to earn these returns without even taking normal risks associated with investments meant for long-term. No wonder, more often than not, our actions belie our aspirations. Simply out, the complete mismatch between how we design our portfolio and what we intend to achieve through it often results in disappointment. In fact, a situation like this often makes us take abrupt investment decisions.

If you are one of those investors who often face a situation like this, you must realise that the key to investment success lies in creating the right balance between risk and reward. It is a proven fact that if one doesn’t take enough risk on one’s portfolio, higher returns would remain a distant dream. At the same time, taking too much risk may turn one’s dreams into worst nightmares. This is where an asset allocation strategy has a role to play. Asset allocation is the process of combining various asset classes such asequity, debt, real estate and commodities into a portfolio. It helps because if one asset class loses money, the other asset class would earn for you. For example, if you invest a substantial part of your portfolio in a risky asset class like equity, long-term prospects improvebut with attendant volatility over short to medium term. 

Similarly, if your portfolio is dominated by debt investments, you are likely to earn stable returns but would invariably struggle to beat inflation. Therefore, asset allocation should be the mainstay of your investment strategy. Asset allocation is a form of diversification that reduces your portfolio risk more than it compromises returns. When you invest in two different asset classes that tend to go in opposite directions in different market conditions, the combination is likely to have a stabilizing effect on your portfolio. For example, the stock market does well during an economic boom, and loses ground during recessionary times. Bond market, however, goes in the opposite direction. While the recessionary conditions are good for the bond market, a booming economy is not so good for it. You must also ensure proper diversification within an asset class.

When you diversify your investments, you reduce the chances of your portfolio suffering from risks associated with having concentrated holdings. In other words, diversification helps in minimizing the impact of any negative performance either in a sector/ industry or an investing style.Besides, your asset allocation strategy must be flexible enough to accommodate the changes in your financial circumstances as well as the changes in the economic cycle. It is important because economic environment has a direct impact on the behaviour of the financial markets. While deciding your asset allocation the key factors should be your time horizon, investment goals as well as your risk tolerance. As different asset classes behave differently over time, a carefully designed portfolio can help in managing the market risk efficiently.

As your investment time frame and goals change, so should your asset allocation. Therefore, be prepared to re-evaluate your asset allocation periodically. It is equally important to adopt the right strategy for investing money in line with your asset allocation. Once your asset allocation is in place, the focus should be on selecting the most appropriate investment options. For example, for a small investor who doesn’t have the wherewithal to invest directly into the stock market, mutual funds can be an ideal option. The key considerations while selecting the instruments have to be flexibility, transparency, tax efficiency and liquidity. Remember, it is never too late to start as well as to revamp your asset allocation plan. If you haven’t been following this strategy, you must have a close look at your portfolio and realign it to create the right balance between risk and reward.