How Well-Balanced is Your Investment?

Equity, as an asset class, has an important role in the wealth creation process of investors. However, considering that the stock market tends to be volatile from time to time, investors must have the patience to not only stay invested during these turbulent times but also continue investing to benefit from averaging. It is equally important to build a well-diversified portfolio to minimise the risk. However, investors often get tempted to invest aggressively into funds that either have a narrow investment universe or a concentrated portfolio. [EasyDNNnews:PaidContentStart]

That’s because they get influenced by the short-term performance of these funds, especially during a bull run. Needless to say, such haphazard investment decisions often take them beyond their risk-taking capacity and put their financial future at risk. It’s not that these aggressive funds should not be in the portfolio at all. They definitely have the potential to enhance the overall portfolio returns provided the timing of entry and exit as well as the selection of funds is right both in terms of potential and level of exposure. 

However, too much reliance on short-term performance while selecting such funds can backfire in the long run. Therefore, the key is to build a portfolio with funds that are diversified by nature. Diversification not only reduces the risk but also allows you to own a well-balanced portfolio that has the potential to perform in different market conditions. While your own risk-taking capacity is an important consideration in the selection process, it is equally important to consider the risk taken by the fund managers while analysing the fund's performance. 

Although having a well-balanced portfolio is important, there is no standard combination applicable to all kinds of investors for deciding allocations to different market capitalisations. Each one of us has a different risk profile, time horizon and investment objectives. Besides, the allocation would differ for a first-time investor and an existing investor. Therefore, it is important to determine the right level of risk tolerance as it can go a long way in helping you design an optimum investment strategy. Besides, it helps in customising fund category allocations and suitable fund selections. 

There are certain broad guidelines to determine risk tolerance. These are:
1. Be realistic with regard to volatility – seriously consider the effect of potential downside loss as well as potential upside gain.
2. Determine a ‘comfort level’ – if you are not confident with a particular level of risk tolerance, then select a different level.
3. Regardless of the level of risk tolerance, adhere to the principles of effective diversification -- the allocation of investment assets among different fund categories to achieve a variety of distinct risk or reward objectives and a reduction in the overall portfolio risk.
4. Reassess risk tolerance at least annually – sometimes your risk tolerance may change either due to major adjustments in return objectives or to a realisation that an existing risk tolerance is inappropriate for your personal situation. 

It is also important not to underestimate risks and or overestimate rewards from an investment. In fact, estimating the risk associated with an investment option is more crucial than estimating the returns. Investing, like many other things, involves risk to achieve returns. By understanding investment risks and how they relate to potential returns, you significantly improve your chances of building greater wealth over time. 

The key factor here should be to invest as an optimist and manage risk as a pessimist. Mutual funds, being diversified by nature, can help you build a well-balanced portfolio. By carefully choosing the right combination of funds tailored to your financial goals and risk appetite, you can effectively balance risk and reward in your portfolio.

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