Investing is a tried and trusted method to build wealth. To ensure high returns on your investment, you should be able to assess your investment portfolio’s risk tolerance capacity correctly. There is evidence to show that strategic and disciplined investors have reduced portfolio risks and have been greatly rewarded for their patience without relying on investment risk management tools.
While as an investor, there is no way to avoid portfolio risks altogether. There are many ways to mitigate investment risks. Here is a list of strategies you can utilize to reduce investments risks achieve a favourable risk-reward proportion.
6 Ways to Reduce Investment Risks-
1. Determine your risk tolerance :
Your risk tolerance refers to the capital you can afford to lose. Risk tolerance is determined based on the financial obligations and your capacity to recover potential losses.
The higher your tolerance for risk, the more aggressive wealth creation strategy you can adopt. Whereas if your risk tolerance is lower, the focal point should be preserving your wealth.
A rule of thumb is that older investors have lower risk tolerance than their younger counterparts. This might, of course, not hold in every instance.
2. Portfolio Diversification :
One strategy to minimize investment risk is simultaneously employing portfolio diversification and asset allocation.
Portfolio diversification involves distributing your investment capital across different asset classes. Standard asset classes are equities, fixed income and cash. Investing across asset classes increases your channels of returns and thus can lead to higher overall returns. Additionally, each asset class has its own risk and reward profile, and some may even be unrelated. Therefore, when one class underperforms, some others may do well and still generate rewards, reducing the risk of heavy losses. A simple trick is to invest in assets with little/no correlation to have a truly diversified portfolio.
Another way to enlarge your portfolio is to invest in the markets of different countries. Geographical diversification secures your assets against the fluctuations of one market by possibly generating returns in the other market.
3. Asset Allocation :
Asset allocation refers to the capital you assign to the different types of investments you have made. For example, suppose you start with ₹ 20,000 and plan to create five other investments. In that case, you can distribute your capital in various proportions, such as 20% per investment ₹ 4,000 per investment. Or you may assign 60% to one investment, i.e., ₹12,000, and distribute the remaining ₹ 8,000 equally. So on and so forth. An important thing to note here is that simply allocating your capital equally across different investments is NOT asset allocation. One needs to keep in mind how these asset classes interact with each other to determine the optimal allocation.
If your risk capacity is low, the advice is to build a conservative investment portfolio. It means that you must exercise conservative asset allocation by primarily investing in low-risk assets such as bonds and cash. This ensures that your principal amount is preserved.
4. Retain as much liquidity as possible :
Liquidity refers to the ease with which you can cash out your investments. The more liquid your assets are, the easier it will be to redeem them. In case of emergencies, be it personal or a result of market fluctuations, liquidity can be a lifesaver.
Another way to secure liquidity is to set up an emergency cash fund. Ideally, only start investing once you have an easily accessible and sufficiently large cash fund.
5. Rupee-cost averaging method :
It is near impossible to determine when the right time to start investing is. One of the best ways to avoid time-related confusion is utilizing the rupee-cost averaging method. The rupee-cost averaging process employs a Systematic Investment Plan (SIP). The point is to invest a specific amount at regular intervals irrespective of the fluctuations in the market. This strategy guarantees that you accumulate more units of an asset when the price is low and few units when the price is high. At the end of the investment period, the average cost of the accrued units is lowered. It also increases your net profit.
This strategy is commonly used when investing in mutual funds.
6. Monitor your investments :
Every smart investor knows that investment is not a one-and-done event. You need to keep track of how your investments are performing regularly. In the case of long-term investments, we’d suggest making reports bi-annually at least. A monthly report would be wise since duration-related risks and volatility are high for short-term investments. On many occasions, you might need to modify your investments and strategies. Whereas, on certain others, you’re going to have to wait for a while to evaluate the effectiveness of the strategy you have used.
The above-listed methods are the most essential and standard practices to reduce investment associated risks. Some other strategies are Risk Diversification, where you can manage risks by spreading your money. If you want to create and multiply your wealth, some risk-taking is inevitable. But you can ensure that these are calculated risks and not just gambles. Employment of a combination of investment strategies can help minimize the risk profile of your portfolio. It is all about customization.
We can help you tailor your investment portfolio based on your financial goals and appetite for risks. Feel free to reach out!
