Risk mitigation through diversification

Risk mitigation through diversification

Risks are a constant in the world of investment. They cannot be eliminated. But, there are strategies to minimise them.

How to reduce investment risk? Investment risk can be reduced by risk mitigation strategies to ensure that the end goal is not adversely affected.

How to manage investment risk? Risk management can be adequately managed through a fundamental component of in investment approach. It is needed to improve investment outcomes. The right strategy keeps losses within an acceptable boundary during hard times and helps to cover up losses during good times. Diversification is one such time-tested risk mitigation strategy. Here are some tips to diversify investment risk.

What is diversification?

Diversification is a means of managing an investment portfolio. Through this one can invest in a wide range of financial assets. So, even if a certain set of your assets do not perform well, it can outweigh the declining performance of the rest of your portfolio. Diversifying balances out and reduces the overall risk associated with a portfolio. Every asset performs differently based on the prevailing market conditions. Diversification is all about investing in various non-related assets to balance out the risk exposure. Non-related assets are assets like equity, bond and gold, whose performance does not depend on each other.

Some assets are also co-related to each other’s performance. For example, equity markets tend to slump during an economic downturn. During such times, the Reserve Bank of India (RBI) tries to stimulate economic growth by lowering interest rates. As interest rates start to fluctuate, co-related assets such as bond prices also tend to go up and down. Thus, equity and debt are inversely correlated to some extent.

In short, diversification simply refers to ’don’t put all your eggs in one basket’. Instead of investing in a single investment avenue, you can invest in multiple financial assets such as stocks, bonds, mutual funds and real estate etc. Moreover, you can also choose to diverse the investments within the same asset class.

For example, you can invest Rs. 10 in different shares of varied sizes, industries and sectors. In doing so, you are at a minimal risk of loss in the event of a fickle market environment.

Thus, a well-diversified portfolio helps you in the long run by spreading out the risk of an asset and minimising overall investment risk, thus helping you to pursue your investment objective. Here it is important to note that though diversification effectively reduces overall risk, it cannot completely erase it.

*The table suggests that the average risk of the portfolio reduces with the rise in the portfolio size.

How to diversify investment risk?

  • Spread your investments across different assets. The risk and return profile of each asset class could vary. Equities are riskier than bonds. Hence, choosing a proper mix of less, moderate and high risk investment avenues can also help in diversifying as per your risk profile and time frame to achieve investment objective. Every asset class responds differently to economic changes. Therefore, figuring out the right mix based on your investment plan is the key to diversification.
  • Consider different assets within the same asset category. To build a diversified equity portfolio, buy 15-20 stocks across varied sectors. Opt for negatively correlated stocks. For example, you can choose to invest in shell stock (oil production companies) and airlines (oil consumer) as the price of these company shares are negatively correlated. Negatively correlated stocks perform better if the other one drops, i.e. contra performance. Thus, diversification helps in averaging out the returns so that if one asset class does not perform well in a timeframe, the other one would make up for it.
  • Remember diversification is an ongoing process. You need to constantly review your portfolio and rework on your diversification strategy based on your current need and situation. A disciplined approach can help you survive the ups and downs of a volatile market.
  • Take expert help. Seeking help of financial experts can help you in building a well-diversified portfolio. Financial experts can help in designing a diversification strategy that can effectively reduce risks and maximize your potential returns in the long run.

In a nutshell, diversifying your investment among various asset classes protects you against significant losses by mitigating risks. Follow an asset allocation strategy as per your risk tolerance, investment goals and financial circumstances. Diversify among and within various asset classes to reduce risks and achieve your financial goals. Get guidance from a financial professional on asset allocation and diversification for your portfolio. IndiaNivesh expertise in the field can help you mitigate the risk through diversification to achieve your financial goals.


Why some assets are riskier than others

Be it stocks, mutual funds, bonds, exchange-traded funds or real estate, there is an element of risk in all types of investment. The only thing that separates them is the degree of risk. In order to understand this better, let’s look at factors such as investment risk management, investment risk and return etc., amongst others that determine the risk level of each investment option. Factors that influence risk element of each assetWhat is investment risk? The risk level of each asset is dependent on its characteristics, investment horizon and behaviour (the way an asset reacts to change in overall market, political and economic environment, interest rates etc.). • Level of volatilityVolatility indicates how rapidly the value of an investment asset can change in a specific time period. This is why stocks are considered volatile. That’s because share prices can change several times in a short time. This means that you can either make a large profit or lose a large chunk of your investment in a short time. A fixed deposit, on the other hand, is less volatile because its value doesn’t change intermittently. This is why fixed deposit returns you receive are fixed. • Time horizonDuration of an investment can determine the risk level as well. For example, a short-term equity investment can be risky because its value changes constantly. But when it’s held for a longer period of time, various studies show that equity is a high-performing asset class. That’s because the price of equity usually flattens in the long run. There is a sense of stability in the long run. Meanwhile, debt investments are relatively safe for short- to medium-term goals. That’s because they provide steady returns if not kept for very long. They can be a long-term investment option as well but the returns may not be able to beat inflation. This is why people usually opt for equity over the long-term and debt investment for a shorter time period. • Nature and characteristicsYou also need to look at the nature of an asset class (equity, debt and gold are some examples of an asset class). Let’s take the example of stocks again. Owning shares of a company means you own a part of their business. You are entitled to company’s profit. You are also expected to bear the loss. This is why stock investments can be a high-risk, high-reward investment. On the other hand, investing in bond means lending money to an entity (it can be a government or a corporate) for a defined period. The chances of losing your money in such cases occur only if the company or the government default. • Asset behaviour towards economyRisk can also be assessed by particular asset’s behaviour towards prevailing economy. For example, market value of bonds reduce with an increase in interest rate and vice versa. Equity investments also get impacted by everyday price movement, industry performance and many other factors. • Individual investor’s risk toleranceIn the end, everything boils down to an investors’ ability to take risk. For example, investing in equity can be a risky proposition for a retired person because they usually look at an asset class that can provide them a steady source of income. In contrast, the risk appetite of a younger person is usually higher and may opt for equity. That’s because they can absorb the short-term volatility and wait for the investment to potentially provide high returns in the long run. To sum upEvery financial asset has a degree of risk. Understanding the nature and level of risk helps you manage those risks effectively to pursue your financial goals. This is why IndiaNivesh can offer you specialised solutions to achieve your financial goals.

read more


How to measure risk?

Risk is inevitable and natural. It affects every investment decision you make as an investor. There is no solution to escape investment risks. Your best hope is to manage risk effectively. What is a risk assessment? Well-managed risk is beneficial in the long run, as risk and return go hand in hand. Hence, risk measurement is a kind of risk assessment procedure which is the first step towards making a wise investment decision and building a well-managed investment portfolio. Let’s understand the types of risk assessment.Types of RiskRisk can be of two types:- Qualitative risk- Quantitative risk Qualitative riskThis type of risk is based on these factors: Financial goals Time horizon  Risk tolerance capacity  The risk of the investment itself How to do a risk assessment? The nature of the investment and its historical performance need to be considered in order to analyse the risk. This can help you compare different investments too. For instance, you have two investments. The investment that has steadily given you a return of 10% year on year is considered less volatile and risky. On the other hand, the second investment gives fluctuating returns, 14% one year, 4% the next year and 10% hereafter. Here, the second investment is considered volatile and a high risk investment option. Quantitative risk assessmentBesides qualitative approach, risk can also be quantified using analytical tools. Thus, in quantitative risk management, risk is calculated on the basis of certain formulae. Some of them are:• Standard deviationIt’s a commonly used statistical tool for measuring risk. Basically, standard deviation is used as a measure of volatility in stocks, stock portfolios and mutual funds. This number indicates how much a particular stock/fund return has varied from its average return over a number of years. An investment is considered risky if its return deviates more from historical averages. For example, stock A and B have given an average return of 10% for last 5 years. But stock A is more risky than stock B as its standard deviation is more and the stock is highly volatile. Let’s take a look at the performance comparison of the above table in a graphical manner below. The standard deviation graph suggests that stock A is prone to fluctuations as compared to stock B.   Alpha Alpha measures investment performance on a risk-adjusted basis. Basically, Alpha means the excess return for any investment as compared to its benchmark performance, thus keeping the risk under adjustments. Therefore, Alpha of more than 1.0 implies that an investment has outperformed its benchmark and compensated more than that of the risk taken. Beta Beta gives an idea of historical volatility. It is used to measure how a stock or a portfolio moves in comparison to benchmark index. For example, beta 2 implies that a particular asset is twice as volatile as the benchmark. Beta shows how sensitive an asset is to market movements. R-squared R-squared helps you gauge to what extent the investment portfolio movement reflects on the benchmark movement. The figure may vary from 1-100%. A higher percentage denotes good correlation between portfolio and benchmark return. Sharpe ratio Sharpe ratio is one of the widely used tools in tracking the performance of an asset. It is a risk adjusted measure of return that helps to compare two similar investments. In mutual funds, two funds are compared on the basis of Sharpe ratio. The fund having a higher Sharpe ratio is considered worthwhile. VIX (Volatility Index) VIX is a widely used measure of market risk. It was introduced in India in 2008 by the National Stock Exchange. VIX measures near-time or upcoming risk. It is based on future and options data and hence gives an approximate idea of near-time volatility expected in the market.ConclusionIn a nutshell, a correct blend of both qualitative and quantitative risk measurements is ideal for performance assessment and to construct a healthy investment portfolio. It is always good to use more than one mathematical measure to analyse risks. Risk measurement techniques are useful in evaluating the risk associated with an investment, thus helping you analyse and compare to make a smart investment decision.

read more

Are you Investment ready?

*All fields are mandatory

related stories view all

  • Value Investing - What is Value Investing & its Fundamentals

    Value investing is the dark horse of stock markets. And this dark horse has created huge wealth for none other than Warren Buffet. Read on to know what value investing is, and what are the critical factors in this strategy. All that glitters is not gold and all that is gold does not always glitter. This holds true for investment decisions as well and forms the core principle of value investing. What is Value Investing? The value investment strategy was popularised by Benjamin Graham along with David Dodd after successfully surviving the period of the great depression. It involves proactively identifying stocks which are trading at a significantly lower value than their intrinsic value. Intrinsic Value refers to the true value of a stock. The two factors behind value investing are market price and value. Price is the amount you pay, and the value is what you get in return. Value investing believes that the stock market does not always remain in an efficient or balanced state. It sometimes overreacts to events such as political announcements, organisational restructuring, economic conditions and results in stock price fluctuations which do not correspond to the company’s actual worth or long-term fundamentals. Hence, there is a good probability that there are undervalued or overvalued stocks in the market. Value Investing and Behavioral Finance Value Investing and Behavioral Finance are two sides of the same coin. Value investing aims to exploit irrational or impulsive behaviour of investors. Emotions heavily influence investment-related decisions. Greed, fear, peer-pressure lead to poor investment decisions. This creates a huge potential for dispassionate or objective investors. Value investors do not get carried away by market sentiments or herd mentality, instead, they look at the real value of a stock in the long run. They also do not fall into a “growth trap” without actually understanding the history or behaviour of stocks. Fundamentals of Value Investing1. Find the intrinsic value Investors who follow value investing strategy are more interested in a stock’s intrinsic value and not just the current market price. There are multiple ways and valuation methods that are used to identify the intrinsic or true value of a stock. Such as discounted cash flow analysis, dividend discount model, Earning per Share valuation, etc. There is also a formula coined by Benjamin Graham to arrive at the true value of a stock. It is:  Intrinsic Value = Earnings Per Share (EPS) multiplied by (8.5+ Twice the growth rate of the company in the coming 7-10 years).  This formula has been now tweaked to reflect the current market conditions correctly. It is now:  Intrinsic Value = [Earnings Per Share (EPS) multiplied by (8.5+ Twice the growth rate of the company in the coming 7-10 years) multiplied by 4.4] divided by current corporate bond (AAA) yield.  4.4 in the above formula referred to the minimum rate of return in the USA in the year 1962. For the purpose of valuation of Indian stocks, 4.4 should be replaced by the corporate bond yield in the same year in India. When the stock’s market value goes below the calculated intrinsic value, investors purchase those stocks. Then they sit back and relax till the time the market corrects itself and the stock price reaches its actual value.  2. Margin of Safety Margin of Safety enables value investors to manage risks and avoid losses. It is also the key element which distinguishes value investing from mere speculation. It refers to the difference between the stock’s current market price and its intrinsic value. Higher the gap, greater is the safety margin. By investing in a stock with an adequate security margin, investors know that any negative event or volatility will not adversely impact the value of the investment. 3. Don’t follow the crowd Value investing is not for those who like to follow the herd. Value investors focus on stocks which are overlooked or avoided by others because of their low valuations but are inherently solid stocks.   Are there risks in Value Investing? Yes. Just like all the other things in our life, there are risks involved in Value Investing as well. One of the biggest risks is falling into Value Traps. All cheap stocks do not translate into good investment decisions. Value traps are stocks which seem to cheap due to low PE multiple or cash flows, but never go up in value. It is important to do full due- diligence before investing. This includes not just financial metrics, but also qualitative aspects such as quality of management, stability, competition, etc. Final Words Value investing is a proven strategy for wealth appreciation in the long run. But it can be an intimidating way of investing without the right support. A partner like IndiaNivesh can make the process smooth and more fruitful for investors. IndiaNivesh is a reputable financial service provider which offers a wide range of services related to Broking, Institutional equities, strategic investments, wealth management, investment banking and corporate finance. With their in-depth understanding of the Indian markets, the organisational experience of three centuries and cutting-edge technological tools, they help investors make well-informed and profitable decisions.Disclaimer: "Investment in securities market and Mutual Funds are subject to market risks, read all the related documents carefully before investing."

    read more
  • Online Trading – 5 Essential Tips for Trading Online in 2020

    Technological advancements and digitalisation have changed the online arena for every business, and the online share trading is no exception to the trend. Over the last few years, online trading has become very popular, especially amongst the millennials and generation Y. Prevalence of smartphones, lower costs, opportunity to earn extra income, low entry barriers, ease of access, etc has had a profound impact on online trading. Even though online stock trading today is huge, and many people are motivated to explore online trading for a rewarding career, by no figment of imagination it should be assumed that it is easy, and they can become financially self-sufficient in a short period. Here are 5 essential online trading tips to help improve your chances of success in your endeavours as a trader-1. Do the research and gain relevant information about the markets The economic conditions are constantly changing and it has a significant impact on the stock markets. To be successful in online share trading you have to do your research, collect relevant information and be updated about matters relating to markets. With information being available at the click of a button, it is easy to get access to information from various sources. Keeping your eyes and ears open about the official announcements being made, reading up market-related articles and financial publications can help you ace the game of online stock trading and avoid making whimsical trade calls.  2. Get acquainted with the trading terminologies and tools Getting yourself familiar with various terminologies and trading tools beforehand is extremely important so that you do not falter when you start trading. Clearing your basics about the important workings, different types of trades, important terms are critical. If you are not clear about the basics, then you may end up placing a wrong order. Once you are trading online, you are investing real capital and you cannot undo the trade. So, it is essential that you must be familiar with the features and the functions of the trading platform which you are going to use. Practice trading on dummy versions to get a hang of the trading interface before you can start with online trading. Once you have enough practice you will not be flustered and confused at the time of real trading. 3. Start with small capital and practice risk management There are infinite opportunities in the trading world and you do not want one experience to be the deciding factor for you. As online trading is risky, you should always make a small start in the beginning and invest little capital. Even the most successful traders do not put their entire investible surplus for trading but use only the capital which they have to spare after they have put aside for their long-term goals such as retirement. So, invest only the capital which you can afford to lose and which will not affect your financial planning. Another important thing to keep in mind at the time of executing trades is that the risk associated with trading is high and hence you should take adequate measures to minimise risk. Setting a stop-loss to your order will automatically stop a trade if the losses hit a particular mark and help minimise your losses. 4. Be patient and disciplined Online trading is a great way to make an income and many have successfully made a career out of it. If the success stories of other traders have motivated you to take the plunge, then, let’s be honest, online trading is risky and not for the light-hearted. Moreover, it is not something you can master overnight or become rich overnight on a single trade. To be successful, you need to have the right mindset and should be disciplined in your approach. Make a trade plan and stick to it. Trading out of impulse or greed will not help you become successful but following a plan and trading when you see opportunities can help you achieve the desired results. 5. Select the right broker and trading platform Last but not least, choosing the right broker and opening the best trading account online is important, and hence you should be careful about your selection. Choose a trading platform that best meets your needs and has a user-friendly interface. You should be comfortable using their software. Your success rate would be greatly affected by the timely execution of your orders. Other aspects to consider are a level of customer service and satisfaction, market reputation and competitive fee structure.   Conclusion With the above essential online trading tips, you can give your income a boost. We at IndiaNivesh have one of the best online trading platforms at the most competitive price and also offer expert advisory and research to meet your investment needs.Disclaimer: "Investment in securities market and Mutual Funds are subject to market risks, read all the related documents carefully before investing."

    read more
  • Tips on Investing Money in Mutual Funds

    Mutual Funds are the cynosure of the financial world. And rightly so! These investment havens pool in money from multiple investors and then invest the corpus across asset categories in line with the scheme’s objective. They are a great option for retail investors who would otherwise find it difficult to get exposure to such varied investment opportunities. What makes Mutual Funds a good investment tool? ·         Professional Management The USP of Mutual Funds is that they are managed by a team of experts. They are equipped with the necessary resources and information to continuously monitor the markets, analyze market trends and conduct in-depth research. As a result, the fund managers can devise the best investment strategy for the investors and guide them regarding the best mutual funds to invest in. ·         Financial Discipline One of the common problems faced by investors is that they lack the rigour or discipline to stick to their financial resolutions. Mutual Funds take care of this issue easily. Systematic Investment Plans ensure that investors continue to invest regularly. ·         Flexibility Mutual Funds offer a great deal of flexibility to investors. You can choose the frequency of contribution as well as opt to increase or reduce the investment amount as per cash flows. ·         Affordable Systematic Investment Plan (SIP) facility makes Mutual Funds affordable to everyone. One can start mutual fund investments with just Rs. 500. That is basically the cost of one pizza these days! They are perfect for novice investors who are overwhelmed or scared of equities but still want some exposure. ·         Tax savings ELSS are tax-saving Mutual Funds. Investment in these mutual funds qualifies for tax deductions (till Rs. 1.5 Lakhs) as per Section 80C. Owing to their potential of higher returns and shorter lock-in period, as compared to other tax-saving alternatives, ELSS have become a preferred choice for many investors.   Mutual Fund investment tips Now that you know what makes Mutual Funds a great investment tool, here are some mutual fund investment tips to help you make the most out of your hard-earned money. ·         Set a goal It is rightly said that “Dreams do not come true. Goals do”. The same rationale applies to investments too. Investments bring the best results when they have a purpose. So, the first step in mutual fund investments should be setting an investment goal. You should consider factors like budget, investment horizon, financial ambitions and most importantly your risk appetite.  ·         Select the right fund type When it comes to mutual fund investments, one size does not fit all. Just because your friend is investing in a fund does not mean it will benefit you as well.  Mutual Funds invest across a range of asset classes. Hence deciding which mutual fund to invest in can be slightly tricky. It is important to choose a scheme that is in sync with your needs and risk profile. For instance, if you are an experienced investor and can afford to take risks, you can easily go for equity funds. However, if you are a novice then most mutual fund tips for beginners will suggest going for debt or balanced funds. It is important to understand the risk-return relationship inherent in each asset category before making a decision. Rule of thumb being – higher the risk, higher the return! The asset allocation should be in sync with your risk appetite. Also, ask yourselves why you are investing in mutual funds. Is it to save taxes? Then ELSS Funds are your best bet. If you have a short investment horizon and want a fund type with high liquidity, then you can go with Liquid Funds. ·         AMC Credibility Check The right fund house can not only help you decide which mutual fund to invest in but optimize the potential of your overall portfolio. It is important to look at factors such as the credentials of the fund managers, expense ratio, components of the portfolio and AUM (Assets Under Management) of the Fund House. ·         Diversification is the key You should not put all your eggs in the same basket. Diversification across asset categories and investment styles is important. It helps to lower the risk quotient as it gets spread over different investments. Even if one fund underperforms, the other can compensate for it. The value of the entire portfolio is not at risk. ·         SIPs vs Lump-sum One of the best mutual fund tips for beginners is choose the SIP way. Especially if you are venturing into equity or equity oriented mutual funds. A SIP will allow you to spread out your investments over a longer duration of time. You will invest at different points in the market cycle and hence even out the associated risk. Also, the power of rupee-cost averaging in SIPs helps to generate higher returns in the long-term. ·         KYC KYC has become a necessity these days. Government of India has mandated KYC for most of the financial transactions including mutual fund investments. So, ensure that you have documents such as PAN Card, valid address proof, etc. before you venture into mutual fund investments. ·         Have a long-term view Mutual Funds are like a committed relationship and not a one-night stand. You need to remain invested for a longer duration in order to get the best rewards. Especially in the case of equity funds. This is because markets tend to be volatile in the short run but tend to move up in the long-term. The best combination is to invest in a mix of debt and equity to get best of both the worlds. Debt Funds would help to lower the overall risk of the portfolio and could help meet emergency fund requirements in the short run. While your equity funds work on wealth appreciation in the long run. ·         Ask the Expert Just like KBC, Mutual Funds also come with a helpline – Ask the Expert! There are so many options available in Mutual Funds. It can become rather overwhelming for a new investor to select the right mutual fund to invest in. A professional expert will not only help to select the right funds and schemes but will also constantly monitor the market on your behalf. One such expert is IndiaNivesh. They offer a wide variety of financial solutions related to broking and distribution, strategic investments, institutional equities, corporate advisory, investment banking and private wealth management. The team at IndiaNivesh has a combined experience of more than 300 years. With their cutting-edge technological and research capabilities, competent team and “client-first” approach, you can be rest assured that you are in safe hands.   Final Words Now that the mystery is solved about how you can select the best mutual funds to invest in, what are you waiting for? Especially when you know that you have a guide like IndiaNivesh available at the click of a button.Disclaimer: "Investment in securities market and Mutual Funds are subject to market risks, read all the related documents carefully before investing."

    read more