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6 ways to reduce investment risk on your portfolio
- While asset allocation of your portfolio is largely dependent on equity, debt and cash, it also depends on many personal factors such as your age, risk tolerance, savings and financial goals
If you are investing in equity-related avenues to get high returns on your investment portfolio without weighing the risks, you might not be heading in the right direction. Every investment is exposed to certain risk factors and the biggest mistake an investor makes is ignoring such risks.
Handle asset allocation properly
While asset allocation of your portfolio is largely dependent on equity, debt and cash, it also depends on many personal factors such as your age, risk tolerance, savings and financial goals. Thus, asset allocation is not only about equity and debt but also about your situation, which plays a big role. For instance, when it comes to asset allocation, a financial adviser will give different advice to a 25-year old and a 50-year-old. The advice will also differ for an age group if one is married and has kids or is single and independent.
“Each investor has a diverse risk appetite and different financial goals. Based on the risk assessment score and the time duration of goals, each investor should decide which asset class (equity, debt, etc.) they should invest in and how much. For shorter time horizons, of 1-3 years, you should keep a debt funds heavy portfolio, and for longer time horizons, equity is a good fit,” said Prateek Mehta, Co-Founder and CBO, Scripbox.
Diversify your investment
When you diversify your investment portfolio across investment product types, your risk on the overall portfolio reduces. For instance, suppose you invest 30% in stock A, 20% in insurance, 30% in fixed deposits and 20% in real estate. So, if stock A price falls, your loss gets limited because 70% of your investments are in other avenues.
Besides, depending on the financial goals that you set out for yourself, your investments should be diversified. “Diversification is about achieving a favored risk/ return objective by constructing a financial portfolio of non-correlated investments. Diversification mainly helps in smoothening out returns. However, investing in too many asset classes relative to the size of your portfolio would be over-diversification, so steer clear of that,” said Mehta.
Monitor your investments regularly
At times, the asset allocation you did a year ago might not work as per the current market situation. In such a scenario, if you don’t monitor your investments from time to time, the investment risk on your portfolio can surge. Thus, it becomes important to keep a track of your investment holdings. You must evaluate them on a timely basis because it helps bring your portfolio back to proper asset allocation, in turn helping minimise the risks.
Identify your risk tolerance capacity
Every individual has capacity to take risk while investing in the market. One must determine the extent of risk one can take as per their age, income, dependents, etc. while making investments. “Often, investors take more risk than is warranted. And it gets highlighted when there is a market downturn. Understanding your risk tolerance and the risks in your investment portfolio could go a long way in avoiding emotional upheavals as well as help you safeguard your money during adversities. Do not chase returns blindly,” said Mehta.
Maintain adequate liquidity
Keep expenses for 3-12 months in liquid and accessible asset classes. Accumulating high volatility products can produce poor outcomes if you need the money when that product or asset is going through a down cycle. By having a cushion of liquid assets, you can let your higher volatility products produce the intended outcomes by being invested in them for the long-term.
Invest through the rupee-cost averaging method
With the help of the rupee cost averaging method, the cost at which you buy units of stocks or mutual funds get an average out. This way, you get a higher number of units when the market is down, and get the least number of units when the market is up. To benefit from rupee cost averaging, you need to invest through SIP or Systematic Investment Plan mode. SIP also helps reduce the volatility factor, and as a result overall gain increases on your investment portfolio.
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First Published:13 Mar 2021, 10:33 AM IST
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