Investment decisions are a complex task replete with risks, unidentified market variables, technical jargon, and economic upheavals. And this dynamic is not easily fathomable to an ordinary investor. One can become an engineer, farmer, expert carpenter, or advanced chemist. But we often learn and improve our financial knowledge and wisdom through trial-and-error techniques. Financial investment is a strategic odyssey for building accumulations of wealth and securing financial stability. But like any odyssey, a financial investment needs deep study, research, planning, direction, and a steady approach.
Here we will try to understand the intricacies of the financial world that will help an investor minimise his risk and optimise returns.
Warren Buffett has rightly opined that “investing is a strategic journey towards building wealth and securing financial stability.
What is return-- The profit or income accrued from
an investment.
What is risk--- Risk refers to the known
variability of investment returns. The biggest risk can be capital loss itself.
- We
should first try to understand the relationship between risk & return
before exploring investment options. Risk and return are two fundamental
financial principles that dwell on the potential return on investment and
the risk associated with it. Risk and market returns are directly related.
It means higher risk means higher return potential, and vice versa. But
there is no guarantee that a higher-risk investment instrument will result
in higher return. Taking greater risks may result in a loss of capital as
well.
Factors that influence the relationship
between risk and return include:
- Market
conditions,
- Investor’s
preference and
- Economic
fundamentals
In the stock market, a small cap has the potential
for higher risk due to its volatility but also has the potential for a higher
return in good market conditions. Stocks have historically had the greatest
risk and highest return potential among other investment instruments. On the
other hand, lesser-risk investments frequently result in poorer returns. All
investments carry some level of risk, as it is very difficult to predict or
time the market. Therefore, developing a successful investing portfolio that
strikes the correct balance between risk and reward is the key.
Benefits of investing:
- Generates
wealth by diversification
- Tax
benefit: investment in ELSS , PPF,NSC LIC, etc lowers tax
implications
- Retirement
planning: One can build retirement portfolio
- Financial
goals: investments help in achieving financial goals
- Passive
income: Through Dividends, interest, and rent
- Emergency
fund: It helps in building emergency funds for any eventuality.
Define your Financial Goals and analyse the market
An investor should beforehand define his goals that
determine the appropriate risk level of his investment. All investors have
different goals depending on their risk appetite and financial needs.
Similarly, a retired person will have a different investment goal than a young
corporate executive.
Staying informed: Knowledge is Power
As has been well elaborated by George Soros, “When
it comes to investing, information truly is power."
To map economic indicators before investing,...
- Stock
market trends
- Global
economic variables
- Inflation
rates
- Interests
rates
- GDP
growth rates
- Tax
implications
Diversification of Portfolios
Diversification of portfolios lowers the risk
as the risk is spread not on one basket but on various investment baskets. A
prudent investor should not base his investment on a single basket but always
spread his investment over different baskets to earn a handsome return.
Diversification offsets losses. You can spread risk and increase possible
returns by diversifying your portfolio among other assets, i.e
stocks,bonds,FD’s real estate and commodities
By having a mix of low-risk and high-risk
investments, you can strike the right balance between preserving capital and
seeking a high return. Diversifying your portfolio across different asset
classes, such as stocks, bonds, mutual funds, fixed deposits, PPF, real estate,
and commodities, can help spread risk and enhance potential returns. This
strategic technique mitigates risk by ensuring that a decline in one asset of
your portfolio is offset by gain in another
When a portfolio is wide spread with different
asset allocations, industries, and investment instruments, it can brave any
fluctuations in the market. In designing the best options for investment, you
just have to select instruments that have a low correlation to each other,
don’t move in tandem, and behave differently to market forces.
Long-Term Investing
Being invested for a long time is a good strategy,
as it provides a handsome return. Long-term investing is where an investor
remains invested for a longer time horizon in the market,which ranges from 5
years to 10 years or more. Investors maintain long security positions in the
expectation that the stock will rise in value in the future.
It is very risky to time the market by buying a
stock at a lower price and then selling it at a higher price. One cannot time
the market in this way, and this may always prove hazardous for an investor.
That is not in the realm of any experienced investor to time the market.
One may get good returns even in a short
time,but it remains a one-time event, and it’s very difficult to get it
replicated all the time. Any impulsive and emotional investment decision may
put our investment at greater risk and may even put it at a loss.
According to Kenneth Fisher, "time in
the market beats timing the market.".
If you are invested in a diversified portfolio for
a longer period, then your investment can outperform the market. Time in the
market is a better strategy for long-term goals i.e kid’s education &
marriage, retirement planning
The benefit of long-term investing is that an
investment gets reinvested to generate greater returns. This compounding brings
exponential growth and skyrockets the investment return. An investor who sticks
with long-term strategic investment is able to sail through the fluctuations of
market forces and take advantage of the exponential growth of wealth. So, an
investment is a long journey for the achievement of an individual’s goal.
Therefore, being invested for a longer period in the market should be the
key.
Cost Matters: Keep Expenses Low
One must always keep tabs on the cost of financial
investment, as there is a likelihood of a reduced profit. While most people
easily pay for their house, vacations, food, and vehicles, they shy away from
paying for high investment returns. Every rupee you spend on fees, whether they
are in the form of management fees, administrative fees, brokerage commissions,
or cost ratios, is money that isn't contributing to your success. An investor
should consider the cost of investment while investing so that it doesn’t
become a burden on his investment.
Risk Tolerance: Profile Mapping
It is very imperative to assess our risk tolerance
to develop a balanced investment planning strategy. An investment strategy may
differ depending on the age, income, goals, and level of risk tolerance of an
investor. Though an investment in the stock market provides a much larger
return compared to other investment baskets, it comes with a higher level of
risk. Maintaining losses requires building a portfolio that aligns with the
investor's risk tolerance.
Benjamin Graham has rightly said that "when
assembling an investing portfolio, it is imperative to comprehend your level of
risk tolerance." -
An investor’s ability and willingness to brave
market changes in the value of his investment is referred to as his risk
tolerance. Some investors who want greater stability and are not willing to
take risks get lower returns, whereas other investors who have a higher risk
tolerance get higher returns.
An investor should be fully aware of his
risk-taking strengths while making an investment. Based on one's risk-taking
ability, an investor should build his portfolio.
Keep You Cool: Stay Disciplined and avoid emotional
investing
"Remain true to your long-term investing
plan; don't let greed or fear influence your choices." Charles Schwab
The temptation and lust for an easy and quick
return, as well as trepidation, often lead an investor astray. Impulsive and emotional behaviour during
investing may mar his long-term investment journey Here, not only a deep
understanding of financial market dynamics is imperative for an investor but
also his mastery over his emotional quotient of his trading psychology. Though
a financial market can be an emotional odyssey, informed investors maintain a
prudent call about when, where, and how much to take a risk. A good investor
should never let lust or fear of money take over his thought process but remain
glued to his long-term goals to realise his investment dreams. Though
maintaining a calm demeanour is a tough ask when emotions start enveloping an
investor. Trepidation, lust, and overeagerness may often cloud an investor's
judgement and lead to poor investment decisions.
Rebalance regularly your portfolio
It is very critical for a prudent investor to
periodically rejig his investment portfolio as per his investment objectives
and market conditions. Every rebalancing entails modifying the allocation to preserve
the risk and return of the chosen fund. Even some funds may be added or pruned
as per the market conditions at that particular time to rebalance the
portfolio. A financial portfolio should always be reviewed, reinvested, and
sold, whatever the case may be, as per the demands of market conditions.
Conclusions
If the above factors are taken into account, then
an investment journey will become very steady and smooth. By getting acquainted
with risk and return, diversifying your portfolio, staying focused on the long
term, minimising cost, knowing your risk tolerance, staying knowledgeable, and
regularly re-balancing your portfolio, you can maximise return and minimise
risk to your portfolio.
Any investment requires a
combination of careful mapping of the profile of the investor,strategic
planning, and his commitment to continuous learning. By implementing 7
essential tips,an investor can position himself for success in the Indian
investment landscape. One should always remember that investing is a continuous
journey that requires continuous learning, adaptability, and a long-term
perspective.
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