Aim to Cut Risks in Your Portfolio

Every investor aspires to achieve investment objectives without getting exposed to undue risks. While some of the proven strategies like asset allocation, following a disciplined investment process and exposure to different segments of the stock markets help in reducing the overall portfolio risk, the key is to identify the right level of risk tolerance and build a portfolio in line with that. Besides, monitoring the progress of your investments in a disciplined and objective manner also goes a long way in minimising the risks of underperformance of the portfolio.

While the path to investment success is well-defined, many investors often follow strategies that expose them to higher risks and that too without guaranteeing higher returns. Therefore, as an investor, you must understand the right meaning of risk. For example, when you invest in mutual funds, the risk refers to the impact of market fluctuations on the NAVs of the funds in the portfolio. Clearly, the impact of volatility is more in the short and medium term and not so much over the longer term. Unfortunately, investors often overreact to the volatility and abandon their long-term investment plans. Needless to say, by doing so, they expose themselves to the risk of earning negative real returns over the longer term.

Remember, asset allocation not only reflects the kind of risks you are taking but also the expected over the defined time horizon. For example, investing for the long-term requires you to stay ahead of inflation and that can be achieved only by investing predominantly in an asset class like equity. However, considering that equity markets tend to turn volatile every now and then, time on hand for long-term goals allows your portfolio’s risk level to remain within your defined risk profile.

Remember, your capacity to take risks emanates mainly from your time horizon. That’s why, it is crucial to have a clearly defined time horizon as well as an asset allocation in line with that. 

It’s a proven fact that portfolio diversification minimises the overall risks associated with investing. Since investments are made across different asset classes and sectors, the impact of market volatility comes down. When you invest in different funds, industry-specific and company-specific risks get reduced. However, over-diversification in your mutual fund portfolio can be counter-productive. Remember, mutual funds themselves are a diversified investment vehicle and hence investing in too many funds, without looking at the underlying securities and sectors, may not result in proper diversification.

Remember, over-diversification usually results in a portfolio consisting of good as well as poorly performing funds. Needless to say, non-performing funds pull down the overall portfolio return. If you are faced with such a situation, you must take stock of the portfolio mix and take steps to weed out nonperforming funds as well as realign the portfolio in a manner that exposure to funds investing in aggressive segments such as Mid-Cap and Small-Cap does not take you beyond your risk-taking capacity.

Investors are often guilty of not participating actively in the decision-making at the time of investment as well as during monitoring the progress of their investments. No wonder, it exposes them to the risk of not achieving the best from their portfolios. While professional and independent advice goes a long way in keeping the portfolio on track, any change in your requirements/ personal situation over time may need a change either in the strategy or asset allocation. Therefore, you need to get involved as an active participant in this process. Besides, being actively involved in the process helps you in having the right mindset, which can be a critical factor in your investment success.