For those who invest in the stock market, “risk” is a familiar word! If there is too much risk involved why does investment happen in the first place?
A seasoned investor will know how to convert this risk to a reward as the risk
becomes a calculated risk and whatever is calculated can be mitigated too!
Now the question is: Are these rules sacred and available only to a privileged few? Of course not! This article attempts to decode some of these rules. Let’s first understand what exactly equity risk is and as a next step learn the rules to mitigate it.
What is equity risk?
In financial world, risk is defined as the volatility of returns but usually investor associates risk with depreciation of value of their portfolio.
To understand it better, let’s take an example. You own an equity portfolio and when market crashes, the value of your portfolio depreciates more than the index in percentage terms and in times of bull market, it appreciates more than the index then your equity risk is higher.
Similarly if the fall or rise of portfolio value is lesser as compared to index your equity risk is lower.
Equity risk is basically a combination of three other types of risk namely — market risk, industry or sector risk and company risk.
Market risk comes into picture because of uncertainty of economic growth, interest rate, inflation etc. Industry risk is the result of uncertainty of growth of a particular sector in economy and company risk arises because of uncertainty of its growth prospect.
How to mitigate it?
So now we are aware that once we buy an equity portfolio or a single stock, we are exposed to equity risk. We might lose a whole lot of money if we don’t mitigate equity risk as it’s a resultant of various factors which we as individuals cannot control. In a situation where we are not at the driving seat, to keep ourselves safe at least we can hold our seat tight.
So let’s discuss the rules of safety one by one which will mitigate the equity risk.
Diversify portfolio
It is common sense that all the sectors of economy cannot collapse at the same instant. In bad times, there are stocks which can shield you better, if you invest keeping equity risk in mind. Rather than putting all your money into a particular sector, balance your investment portfolio by investing into defensive (food, medicine, public utility) and cyclical stocks (auto, real estate, sugar, cement, commodities etc). Even if the market crashes, this part of portfolio will protect the overall value of your investment.
Invest in MFs
Diversify your portfolio not only in terms of sectors but also in terms of investment options. To mitigate equity risk, you should diversify your portfolio by investing in other equity asset classes like mutual fund and index funds.
Invest for future
Don’t get swayed by the short-term reaction of the market as it is a known fact that if you invest in equities from a long-term perspective you rarely loose.
If you have researched well and are confident about the health of the economy, just stick to your investment decision.
Foreign exposure
If you have knowledge and resources, you can diversify your equity portfolio by investing in equity markets of other countries as it will mitigate your risk when the local economy is not in good shape.
No penny stocks
Equity exposure is risky in itself and one should not make the situation worse by investing in penny stocks. If you take exposure in them, no mitigation steps can save your bank account.
All said and done, there is one final word: Do not invest under the assumption that it is possible to bring this risk to zero as that is an impossible task. In trying to achieve this, you will do more harm than good to your portfolio. These steps will help you in minimising the risk if you stick to them religiously.
(The writer is the CEO of bankbazaar.com)