No bear hug for calculated risk!

By BankBazaar | June 8, 2012

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 finance, 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 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 our self 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 your equity 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 State, Cement, Sugar, Commodity etc). Even if the market crashes this part of portfolio will protect the overall value of your investment.

Invest In Mutual Funds –

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 from long term perspective –

Don’t get swayed by short term reaction of the market as it’s 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.

Take exposure in foreign equity –

If you have knowledge and resources diversify your equity portfolio by investing in foreign equity as it will mitigate your risk when the local economy is not in good shape.

Keep safe distance from 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.

 

Conclusion

All said and done one final word – do not invest under the assumption that it is possible to bring this risk to zero as that’s an impossible task. In trying to achieve this you will do more harm than good to your portfolio. Steps suggested above will help you in minimizing the risk if you stick to them religiously. Happy Investing.

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