Smart Investing: Five ways to reduce investment risk

Then there is price risk, which is decline in value of the investment instrument resulting in loss of capital, inflation risk causing corrosion in purchasing power.

Then there is price risk, which is decline in value of the investment instrument resulting in loss of capital, inflation risk causing corrosion in purchasing power.

By Sethurathnam Ravi

Investment needs of an individual are driven by various goals and objectives varying from self/ child education, children’s marriage, retirement needs, creating a fund for down payment for buying a house, travel funds, emergency fund, etc. Basis the needs and the goals of investment, individuals assess their risk tolerance appetite, time available to meet the objectives and ability to replace capital erosion. Investment decisions are guided by the traditional investment principle of risk-return trade off that relates high risk with high returns.

Current markets offer various investment products catering to the investment needs ranging from fixed deposits, debt securities, equities, mutual funds specialising in debt, equity or hybrid, SIPs, ETF, Gold, real estate, currency and so on carrying different kinds of risk associated with them, of which certain are controllable and certain are not. There is market risk that is fluctuation of returns caused by macroeconomic factors and political risk which arise because of change in government’s policy changes, which are not controllable.

Then there is price risk, which is decline in value of the investment instrument resulting in loss of capital, inflation risk causing corrosion in purchasing power. There are also other risks such as risks on account of fluctuation in interest, default risk (non-payment of principal and interest of debt), volatility risk i.e., daily/ frequent fluctuation in prices, concentration risk which is on account of investing in a single type/ sector/theme of asset, currency risk in case of portfolio of investment includes investments in markets abroad/ in forex instruments.

Some of the tools at the disposal of an individual that he/she must consider to mitigate different investment risk includes:

Due diligence
It is essential that before any call on investing, research should be carried out. For example, It is pertinent that before investing in a stock one checks earning growth, PE ratio, debt load, management team and then compare it with other stocks in the same industry on key parameters. Stocks with high PE ratios, unstable management and inconsistent profitability and revenue growth could be eliminated.

Capital allocation
Out of the total capital available for investment, assign amounts in different class of investment such as debt, equity or mix of both depending on growth requirements of capital. In case an individual starts investment at an early age, then investing in equities offering higher returns over long duration of investment would mitigate volatility and inflation risk. On the other hand, debt instruments like bonds have high inflation risk over time and are susceptible to interest fluctuations.

Portfolio diversification
This entails selection of various investments products, exposure to equity belonging to different sectors, mix of various options available for instrument. As a strategy, there could be a possibility of lower returns but would result in alleviating risk of substantial capital loss.

Monitoring portfolio
It is essential at periodic intervals. For instance, at times of lower interest, price of debt securities moves up and could provide an opportunity for switch in the portfolio. In case an individual cannot manage the monitoring, it is advisable to shift to Mutual Funds to protect the capital.

One needs to evaluate the currency risk i.e., in case of sectors such as IT and pharma, opportunities arise when rupee is weak and in case of capital goods & power sector, strong rupee improves investment prospects.

Blue-chip stocks
In order to ease loss of capital and avoid liquidity risk, it is ideal to stay invested in bellwether stock or fund. Investors should watch out for credit rating of debt securities and could invest in better rated securities to avoid default risk.

The quantum of money invested, period of investment, return and growth, expenses associated with it and risk tolerance impact our achievement of investment goals. All types of investment products/ securities carry some or the other risk. One must consider the risk appetite which is determined basis the wealth/ net worth as well as risk capital in hand before deciding on any investment. One should be careful that investment decisions should not jeopardise the lifestyle.

[“source=financialexpress”]