6 ways to reduce investment risk on your portfolio
Investors
are always worried about risks facing their portfolios. Many investors lose
money due to these risks. Though there is
nothing like a risk-free investment but
there are definitely some smart ways to reduce the risk and earn money in stock
market.
How to
Reduce Risk When Investing In Stock Market
1. Diversification
of Portfolio
Diversification
of shares in your portfolio reduces the risk by spreading it across to a
variety of shares. You can diversify your portfolio by keeping shares of different industry sectors or different company
sizes, etc.
It
is a good risk reduction strategy to invest in varying industry sectors like
pharmaceutical sector, real estate sector, FMCG sector, banking sector, etc. So
if one industry sector in your portfolio is not doing well, companies in other industry sector may be doing well. Like
for example – If banking sector is facing a downside, it may be possible that
real estate sector is booming.
Similarly,
you should invest in companies of different sizes. Reason being, small and
relatively new companies have a higher
potential for growth but at the same time
are risky. On the contrary, large companies are more stable and have good
performance record making them less risky. So it is advisable to have a mix of
different company sizes.
2. Stay
Invested for Long Term
Be a long term investor, instead
of being a short-term speculator. Buying stock and holding it only for a few
hours or weeks is not investing, it is gambling. Moreover, the stock market is subject to short term
fluctuations. Short term trading is risky and there are chances that you may
experience a major fall in the price of your holdings during short-term.
On the contrary, long term
investments are safe and yield better returns. The longer your investment
horizon, the more likely the stock market is to rise. A long term investor is
not affected by short term fluctuations and bear market
3. Seek
Advice
You
are inviting risk by investing in the stock
market without having knowledge of the same. If you invest without knowledge,
you are gambling and it can result in
losses. Investing in the stock market
requires a good understanding of how the
market works, what triggers the prices of stocks and how an investment strategy
works. If you lack the knowledge, you must seek advice from qualified advisors
who can guide you on investment strategy keeping in mind your risk tolerance.
4. Analyse
Company’s Background and Performance
It
is extremely important to research about the company you are going to invest
in. You must look at the companies past performance, investment history, debt
load, earnings growth, management competency and lot many other factors. Also, analyse the Price Earnings ratio (P/E
ratio) of the company to measure the market value of a stock relative to its
earnings. Pick stocks with lower P/E ratio as they are less risky.
5. Determine
Your Risk Tolerance
Every
investment carries some level of risk. Though it is impossible to eliminate the
risk completely, but you can definitely
reduce the risk. Determine your risk tolerance by analyzing two factors - your net worth and risk capital. Net worth
is your assets minus your liabilities. Risk capital is the amount of loss you
can bear on an investment without impacting your lifestyle. If your net worth
is high and risk capital is substantial, you can have a higher risk tolerance.
Similarly, with lower net worth and risk capital, you should adopt a
conservative approach and go for lower risk tolerance.
6. Monitor
Your Investments Regularly
Be
watchful of your investments. Monitor and consider reallocating your
investments regularly. Allocation of investments depends on factors like your
age, investment horizon, risk appetite, investment goals, etc. Asset allocation
not only helps in maintaining the balance in your portfolio but also helps to
achieve your goals. Let’s say if you have
decided to invest 50% of your capital in large cap stocks, 25% in small cap
stocks and 25% in short term bonds. Then once a year you should evaluate your
holdings and rebalance your portfolio to bring back the decided asset
allocation.
These are few effective ways to reduce stock market risks. Once
you learn the tricks to avoid risks, your chances of losing money in stock
market drastically reduce. So before you think of returns, figure out the risk
and determine your risk tolerance.
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