This article has been written by Sunil Kumar Pathak pursuing an Executive Certificate Course in Corporate Governance for Directors and CXOs from Skill Arbitrage.

This article has been edited and published by Shashwat Kaushik.

Introduction

An investor’s perspective is frequently shaped and moulded by his worldview, the objects in his environment, and his attitude towards financial goals. An investor often makes a decision based on his financial knowledge and wisdom, as someone’s outlook towards finance may make sense to him but seem crazy to others. We all make investing decisions based on our perceptions at a given moment. Navigating the world of investment is quite thrilling in the case of a profit and quite disappointing in the case of a booking loss.

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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. However, 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.”

Understanding risk and return

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 a 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 preferences, 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 a 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 define his goals beforehand, which will 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.”

Any relevant information and knowledge regarding financial investment is power. An investor should always be well-abreast of market dynamics and geopolitical conditions while making financial investments. Every investor should do thorough research, read offer documents, and consult his or her financial advice before venturing into any investment. But at the same time, the investor should not be overwhelmed with a plethora of information. As it may cloud his judgement. Efforts should always be made to learn new tips and be informed, and that makes an investor’s objective and plan easy.

To map economic indicators before investing with:

  • 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 in your portfolio is offset by a gain in another asset.”

When a portfolio is diversified 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, and retirement planning.”

The benefit of long-term investing is that an investment gets reinvested, and the fund gets compound 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.

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.

Conclusion

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.

References

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