Drawing a considerably thick paycheck doesn't always ensure the secure financial future of your dreams. While a single source of unwavering income is not something to be taken for granted, well-managed investments add much weight to your wealth creation journey.
But just like everything in life, investing money has its risky flipside. While some investors could be inclined to draw good returns to grow their wealth quickly, others could lean on safer bets that protect themselves against market volatility. This is when risk management strategies work wonders, as they offer the best of both worlds.
How to Frame an Investment Guide
Let's understand how you can frame an investment guide to minimize overall risk while maximizing your long- and short-term gains at the same time.
Have Appropriate Asset Allocation
As the name suggests, asset allocation mainly deals with investing in multiple asset classes for a logical reduction in risk, which might otherwise arrive from hinging on one class. In practice, investors can cook up a perfect mix of debt, mutual funds, equity, real estate, gold, and so on for optimal returns.
Investing simultaneously in inversely related asset classes is also advisable to ensure a consistent inflow of returns even through market fluctuation. For instance, equity and gold offer a pairing where, when one performs exceedingly well and the other is likely to tank, the two balance each other out. While framing the distribution of capital into different asset classes, be sure to factor in your investment timeframe along with all the possible risks and rewards of the asset classes under consideration.
Diversify Your Portfolio
Now that you have struck the sweet spot regarding asset class distribution, further diversifying your investment in the same asset class is a smart move. This guarantees an extra decrease in the overall investment risk. One such tactic is to diversify the equity mutual funds asset class by putting money in all the three buckets, i.e., large, middle, and small-cap funds.
This tactical diversification will ensure that large-cap companies keep their portfolio afloat when the market crashes small-cap sink companies. On a related note, simple mathematics suggests that losses are limited by the exclusive distinction of investments, thereby minimizing the chances of an all-around drop in gains. In essence, what portfolio diversification does is smoothen out returns in a seamless fashion.
Diversification seeks to reduce the volatility of a portfolio by investing in a variety of asset classes. Neither asset allocation nor diversification guarantee against market loss or greater or more consistent returns
Assess Risk Tolerance
One of the more vintage investment sayings advises only investing as much as you're comfortable losing in whole, and this is what makes up the essence of Risk Tolerance. In theory, it entails the investor's ability to ensure the risk of losing the invested capital, and it usually depends on their financial state and age. It is only logical to presume that younger, unmarried investors face fewer monetary challenges and financial responsibilities than the older investors in their late 50s, making them much more risk-tolerant.
This understanding can be extended to state that the investment strategies deployed at the beginning of a career are in stark contrast to those used when nearing retirement. The former is aimed at aggressively growing your wealth, while the latter focuses on sustained wealth preservation.
Taking more risks than can be handled can often lead to blood-red portfolio returns. Therefore, assessing your risk tolerance and configuring your investments accordingly makes sense for the best risk-return value. Not only does this help avoid emotional upheavals during a market downturn, but it also safeguards your investments during dark times.
Have Enough Liquidity for Emergencies
Financial emergencies often seek instant cash, and maintaining sufficient liquidity in your portfolio can be a massive bane in such trying times. Pre-existing liquid assets ensure that our other investments deliver good long-term gains while we service our urgent requests on the side by redeeming our liquid investments.
Maintaining an emergency fund that can handle 6 to 8 months’ expenses is one of the keys to maintaining adequate liquidity. Opt for low-risk investment options like liquid funds and overnight funds for easy accessibility of these emergency stashes.
Take to Periodic Monitoring
It is always a good practice even for long-term investors to keep checking in at regular intervals for periodic reviews of their portfolios. Investments showing poor returns over an extended period of time can be churned out for more lucrative alternatives. However, some asset classes like equities are prone to short-term volatility and can be overlooked case-to-case basis.
Checking and recalibrating once every six months can work in your favor. Switching and shuffling the investments far too frequently can often be a disaster. Let the investments breathe for a certain number of months before making a final call. Constant shuffling disturbs the power of compounding and can cost you tons of returns in the long run.
Employ Dollar-cost Averaging
Dollar-cost averaging is aimed at using a particular amount to purchase mutual funds, stocks, etc., thus ensuring the purchase of more shares when the market is down and fewer shares when the market is up. From a mathematical standpoint, investing the same dollar amount on a regular and periodic basis will lower your average cost per share and, at the same time, reduce the risks of blindly trying to time the market to perfection.
Dollar-cost averaging takes emotions out of the decision-making process and demands patience and discipline for long-term gains strategically. Essentially, it helps smooth out the market fluctuations from heavily affecting your portfolio.
Dollar cost averaging involves continuous investment in securities, regardless of the fluctuating price levels. Investors should consider their ability to continue purchases through periods of low-price levels or changing economic conditions. Such a plan does not assure a profit and does not protect against loss in declining markets.
Although the risk is an evergreen element in the investment journey, it is the tradeoff you sign up for in the quest for increased returns. Since the existence of risk can never be fully eradicated from the picture, you can always learn to manage it efficiently via some intuitive investment tactics. A well-curated risk management strategy is how investors can ensure that the losses never exceed their personally acceptable boundaries. If you're someone looking to build a solid financial backbone, head over to Central Financial Group. We can create personalized investment strategies tailored to meet your monetary needs and long-term financial goals.