Risk management is the process of identifying risks, analyzing them and taking adequate measures to curb these risks to achieve the desired results. The term financial risk management is most often associated with businesses; it is equally important and applicable to your investment portfolio.
Risk management process in financial investments comprises of determining the risks that exist for the particular investment and implementing strategies to mitigate the risk in the way. Risk management is an important aspect of investing as it helps reduce the risk depending on your individual goals.
Whenever you make investments, you try to look at the potential returns from the investment. However, just like the returns, there is also a degree of risk attached to the investment. Your choice of investment will depend upon your financial requirements and the level of risk you are willing to take for your investments.
Types of risk management
People today are living healthier and longer, thanks to the rapid advancements in the medical world. However, living longer also means that you need to plan your investments for a longer retirement. This risk of outliving your money is known as longevity risk.
You need to take adequate measures to limit this risk. Some of the ways to can mitigate this risk are by investing for retirement corpus from an early age; keeping a high savings rate in working years, look out for second employment post-retirement, etc.
Inflation is a constant increase in the cost of goods and services in the country. Inflation reduces the purchasing power of money and higher inflation means we can buy fewer things in the future as compared to the past or present for the same amount.
As an investor, you need to select assets and implement investment strategies that have potentially higher returns much above the rate of inflation. When you are investing in fixed income instruments such as a Bank FD, Corporate bonds, etc. always be watchful that the return on investment is above the inflation rate.
Interest Rate Risk
Change in the interest rate can affect your portfolio. When the rate of interest is high, there is a decrease in the value of corporate bonds. A higher interest rate can have impact on an industry or a sector, which in turn could affect your equity investments if they are impacted negatively by the increased rates.
Diversifying your investments in different asset classes, choosing debt investments of varying maturity can help you limit the risk associated with the changing interest rate.
Many people associate liquidity risk with just real estate investments. Undoubtedly real estate is one of the most illiquid assets, but many other investments to have a lock-in period and pre-mature withdrawal attracts a penalty.
To protect yourself from liquidity risk, it is important that you have an emergency fund in place and also limit your exposure in assets which are difficult to liquidate or involve incurring expenses.
Market risk is the risk associated with the decline in the value of your investments due to economic or other developments, which affect the entire market. Market risks are unavoidable when you make any investment, however, you can lower the impact on your investments through adequate measures.
As an investor, have a well-diversified portfolio in different asset classes such as equity, debt, gold, etc. as not all the assets would not be affected in the same way or magnitude in any development. Moreover, you can reduce the risk of wanting to time the market by buying stocks at different times to average out the cost of your investments.
Credit risk applies to debt investments such as bonds and corporate FDs. It is the risk of the inability of the issuing entity to repay the interest and/or interest on maturity.
As an investor, you can mitigate credit risk by looking at the credit ratings of the issuer. Higher the rating, the lower is the risk. AAA bonds have the lowest credit risk.
Risk management process to mitigate the various types of investment risk in your portfolio
- Goal setting and investing as per your requirement
Investments are made keeping in mind your individual goals and needs, your time frame of investment and your tolerance to risk. Once you are clear about all these things, you can allocate your savings in assets which would help you achieve your goals in the desired time frame. It is important to remember that long-term investments in growth assets may be volatile in the short-run and you should not make any hasty decisions.
- Portfolio Diversification
Diversification is the process of distributing the investments in your portfolio in different asset classes. Diversifying your investments in different assets such as stocks, bonds, commodities, gold, etc. helps reduce the overall risk of your portfolio as the performance of all the assets is not correlated and in a given economic condition the performance of the asset classes will not be same. Diversification is one of the most crucial risk management techniques for you to mitigate the risk of your investment portfolio as it helps you to take advantage of the different price movements of different assets.
- Regularly monitor your investments
Depending on the performance of various asset classes in your portfolio, their percentage holding in your portfolio may change from the original allocation. Thus, monitoring your portfolio regularly and rebalancing would ensure that your portfolio remains well-diversified.
- Take financial advice from experts
Financial planning and risk mitigation of your portfolio requires knowledge, time and expertise. Taking the help of financial experts, who can guide you to select the right financial products as your risk profile and unique investment needs.
A disciplined approach to your investments and sticking to the basic principles of risk management will help you achieve your financial goals. If you are unsure on how to manage risk of associated with your investments and need guidance to help you prepare a portfolio most suited to your investment needs and minimising risk, you can consult our financial advisors at IndiaNivesh who can help guide you through your investments and also manage your portfolio risk. Disclaimer: "Investment in securities market and Mutual Funds are subject to market risks, read all the related documents carefully before investing."