The act of investing involves allocating funds into a scheme that may accumulate wealth for the investor over time. However, it is important to note that investments come with numerous risks. While it is understandable that one may be afraid of investing in financial assets due to the element of “risk” in it. But, if you were to go ahead with investing and continue to do so continuously over time, there may be rewards for that. It is important to make note of the fact that successful Investing is all about managing risk and not avoiding it.
While seeking success in investments, investors need to remember that managing risk doesn’t mean totally avoiding it. Please keep this phrase in the mind, “No risk no return”. Therefore, you need to go high if you want to get more from your investments. There is always going to exist some element of risk when you opt for investment plans. Listed below are some of the risks:
General risks of investments:
- Investments in mutual fund units come with investment risks such as trading volumes, liquidity risk, settlement risk and default risk including the possible loss of principal.
- When the value/price/interest rates of the securities in which the scheme invests fluctuate, the value of the investment portfolio in a mutual fund scheme may go up or down.
- In addition to the factors that affect the value of individual investments in a scheme, the NAV of the scheme may fluctuate with movements in the broader equity and bond markets.
- Past performance does not guarantee the future performance of any mutual fund scheme.
Strategies to manage risks:
But there are some guidelines that you can follow to manage risks efficiently. Listed below are some of them:
- Understand your risk tolerance:
In simple terms, risk tolerance is the ability of an investor to endure the risk of losing their capital i.e., the money they invested. Risk tolerance is mostly dependent on the investor’s age and current financial obligations. For instance, if you are in your mid-20s, unmarried and have fewer financial responsibilities then you are more risk-tolerant compared to someone who is in their late 50s and is married with college-going children. Hence, as the general rule, younger investors are more risk-tolerant than older investors. Therefore, if you were to start investing early in life, then you can begin your investment journey with an investment portfolio having pure equity that is mainly focused on aggressive wealth creation. However, it is important to note that this strategy is not recommended for investors who are about to retire. Instead, they need to focus on wealth preservation. By ascertaining what is your risk tolerance, you can figure out investments according to the best risk-return value for managing your investment risk.
- Keep your portfolio liquid:
Whether you are investing or not, it is important to note that a financial emergency can strike at any time. So, you may be tempted to redeem your investments whenever the markets are down. However, risk can be mitigated if you were to maintain adequate liquidity in your portfolio. If you were to keep your portfolio liquid, the existing investments can deliver optimal long-term returns and you could also enjoy benefits from any periodic market corrections.
One of the ways of maintaining sufficient liquidity in your portfolio is setting aside an emergency fund that should be equal to 6 to 8 months’ expenses. To ensure that there is easy access to emergency funds, you should opt for low-risk investment options. After determining the risk tolerance and keeping some money aside for ensuring adequate liquidity in your portfolio, it is time to formulate an asset allocation strategy that works for you.
- Formulate a suitable asset allocation strategy:
Asset allocation refers to the act of investing in more than one asset class for reducing the investment risks and this strategy also provides investors with optimal returns. You can invest in a perfect mix of key asset classes like equity, debt, real estate, mutual funds and gold.
- Diversify your investments:
After formulating a suitable strategy for asset allocation, you can further reduce the overall investment risk by diversifying your investments in the same asset class. Meaning, that if you are investing in equity mutual funds, then you can diversify in this asset class by investing in things like large, middle or small-cap equity mutual funds. During a market crash, the prices of small-cap companies fall faster as compared to large-cap companies. Hence, by diversifying your portfolio, you will be reducing the overall investment risk.
Investment planning can help you to achieve your financial goals. One of the aspects of planning for strategies for mitigating risks as every investment comes with risks. Implementing the strategies above will help you to find an appropriate balance between returns and risks.
Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.