No portfolio comes with zero risk, so these are 4 ways to reduce risk of your investment portfolio
A constant companion to your investment portfolio that you need to take guard against is risk. The quantum of risk is significantly higher when you invest in equity stocks as many factors influence their price movement. Risk exists in the bull and bear markets, and hence an intelligent investor deploys risk management strategies to hedge his portfolio and preserve the gains.
These all-weather strategies are have proved their worth time and again, and implementing them can help you ride choppy waters with ease. So, what are they? Let’s find out.
One of the core tenets of investing, optimum diversification ensures that the risk is spread and distributed throughout the portfolio. Diversify across stocks - large-cap, mid-cap, and small-caps - and asset classes to provide stability to your portfolio. Note that you don’t need too many stocks/funds to diversify.
A couple of large-cap funds with one mid and small-cap is enough to achieve the required diversification. Go for fundamentally robust funds with a long-term track record. It’s prudent to invest in stocks and funds that have delivered consistent returns over the years. Also, study the underlying portfolio and ensure they are different.
Often in the name of diversification, investors tend to invest in funds/stocks of similar nature. You must avoid it, as doing so will make your portfolio bloated and make tracking difficult.
Invest as Per Your Risk Tolerance
Knowing your risk tolerance will help you zero in on instruments in line with your risk appetite. More often than not, we, as investors, don’t have an accurate estimate of the quantum of risk that we can take. Particularly during the bull run, when bourses are at an all-time high, investors tend to overestimate their risk appetite and end up pouring their money on risky bets.
Hence, it’s crucial to understand how much risk you can stomach and invest accordingly. There’s little point in losing your sleep for fear of losing gains made painstakingly over the years due to market volatility. To accurately estimate your risk tolerance, rope in a financial advisor who will help you understand the levels of risk you can take.
Ensure Sufficient Liquidity in Your Portfolio
There can be situations where you might want to get rid of certain investments due to poor performance or in a financial emergency. You can hedge against such risks by maintaining enough liquidity in your portfolio. To do so, invest in products that you can liquidate quickly. Also, having liquid assets in your portfolio enables you to sail through an emergency.
Locking a chunk of your investments in assets such as real estate can prove to be counterproductive, particularly when you require funds on short notice. Therefore, it’s prudent to make sure you maintain ample liquidity always.
Periodic reviews help to identify loopholes and plug them. Review your portfolio once in six months or in a year to monitor the performance of your investments. Closely analyze and weed out non-performers. However, before making any drastic change, review the cause of underperformance. Is it because of weak fundamentals or something else?
Note that when markets nosedived in March 2020, even fundamentally sound stocks took a beating. However, there was nothing intrinsically wrong with them. Most investors, however, panicked and pressed the exit button, turning notional losses into actual ones. So, you must guard yourself against such behavior and undertake the review exercise carefully.
No portfolio comes with zero risk. While you can’t get off it completely, you can minimize it by adopting the aforementioned strategies. Optimum risk management can help you grow your wealth and achieve goals with ease.
Source : Money Control