The element of risk is always closely tied in with any investment activity that we choose to participate in. As undesirable as it may seem to be, it’s something that we must take into account while making investment decisions.
Forewarned is forearmed
Gaining some prior knowledge before you plunge into the risk-reward-laden investment market can help you gain that much-needed tactical advantage to meet your financial goals. This would entail taking a comprehensive look at your portfolio to assess the impact that external economic factors might have on it. It would be a good idea to understand how these risks could affect your investment performance over the long term. Let’s examine these risks to ascertain measures that can be taken to counter their long-term adverse effect on our investment portfolio.
The following are the five broad classifications of types of investment risks.
This is the risk that arises from the price fluctuations that take place in the market and is perhaps the first risk people think of when they hear about investing. While there is always a notional loss of value whenever the price slips below the invested amount, true loss only occurs if the asset is sold.
An investor with a conservative approach to investing would prefer to park their funds in low-risk investment vehicles like savings accounts, CDs, and government bonds. While this seems like a safe bet, the risk in this scenario is that their investment returns might fall below the inflation and thus result in a reduction in the value of their investments.
Interest Rate Risk
This refers to the potential risk of a reduction in the value of a bond or other fixed-rate investment due to a change in the interest rates. The bond prices fall with a rise in interest rates and vice versa. Hence no matter how safe government and high-quality corporate bonds are there is still a possibility to lose money on them.sk factor involved in case of extreme dip in interest rates.
Investors who need ready access to cash need to take into account the liquidity risks posed by different investment alternatives. You could lose a part of your principal if you prematurely redeem your secure investments such as CDs. Although investments such as stocks, bonds & MFs are more liquid you may not want to sell them at a loss when you are in need of funds.
How to reduce investment risk?
Diversify across assets
Each investment product comes with its own set of risks. A well-diversified portfolio will help you mitigate the risks inherent in the investment products by reducing your overall exposure to them. If your sole goal is to maximize the returns in your investment portfolio then you might end up putting the bulk of your capital in equities. You should consider your financial goals and current situation (age/dependents/risk tolerance) while deciding on the proper allocation of funds across equity, debt, and cash.
Each individual has a different approach to the risk-reward trade-off that they are willing to handle. You can understand your affinity to risk through your risk assessment score and then decide which asset classes you should go in for and what time horizons are you looking at.
Keep an eye on your portfolio
Market conditions are quite dynamic and keep changing. You need to periodically monitor your portfolio to check if the asset allocation you did last year continues to deliver the results that you expect from your investments. It helps to keep your investment portfolio on track towards achieving your financial goals.
A healthy dose of Liquidity
You must ensure that you have access to enough funds that can last you for roughly 3-9 months of a year if such a need arises. This can act as a buffer to stop you from dipping into higher volatile liquid assets that can provide you greater returns in the long term.
Benefit from rupee-cost averaging
When the market is down you would naturally get a higher number of units and vice versa. The rupee-cost averaging method allows you to average out your cost of investments through volatile market movements. You can easily gain access to this through Systematic Investment Plans which helps you reduce the impact of the volatility factor while investing and thus increase your overall gain.
While there are myriad risks associated with the activity of investing, an astute investor can also plan out an effective investment strategy through prudent investment diversification and asset allocation. As always in such cases, it’s good to keep a long-term view and not be driven to rash decisions caused by short-term market movements.
Risks are an inherent part of investing. To better understand your appetite for risks connect with our experts to evaluate your risk profile today.
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