Perfect Equity Portfolio Comes With Its Share Of Risks

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  • 23 Jan 2023
Even a perfect equity portfolio comes with its share of risks

Investors often dream of the perfect investment portfolio. The one that promises great returns with minimal to no risk. The reality is, however, that an ideal risk-free portfolio is practically impossible. In its very nature, equity investments carry some risk no matter how carefully you choose your investments.

Here is what you need to know about the risk of equity investments, the myth of safe investing, and how to create a good investment portfolio.

Equity brings volatility.

Equity investments are highly susceptible to market volatility because they invest in shares sold on stock exchanges. Stock exchanges tend to be volatile and unpredictable as they can be affected by any number of factors ranging from politics to economics. Thus, the volatility of market movements impacts equity investments. The good news is that despite this susceptibility to volatility, equity investments are good as long-term investments as they have the potential to grow the investor’s money faster than inflation can shrink it.

Factors that can affect equity investments

Many factors can affect equities, such as the introduction of a new government policy, or when the Reserve Bank of India (RBI) revises the Repo or Reverse Repo rates. Other factors, such as foreign investment entering or exiting the market, political announcements, events, or natural disasters, can cause market volatility. Global events can also send stock prices tanking or surging. Moreover, equity shares can be affected by a company's performance, such as management changes, poor product reception, or mergers and acquisitions.

The risk of ‘safer’ investments

Does this mean that investors should look for ‘safer’ investments to mitigate risk? Not necessarily. Investors will trade one type of risk for another by creating a cash-based portfolio by investing in government bonds, certificates of deposits, etc. These investments may help reduce short-term volatility; however, inflation eats away at the purchasing power of cash-based investment in the long term.

No such thing as risk-free investing.

For long-term investors, there is no such thing as risk-free investing. The world is not risk-free, and since the stock market and equities are affected by what is going on in the world, they too, are not risk-free. Investors can only choose to minimise their risk and invest as per their risk appetite.

Don’t aim for the perfect, aim for reasonable.

Investors should aim for well-diversified portfolios that would enable them to achieve their investment goals. Here is how they can do that:

  • Risk tolerance assessment – Risk and return are inversely related; the higher the risk, the greater the potential for returns. Before choosing investments, the investor should assess their risk tolerance thoroughly.
  • Diversify – Invest in different market sectors. Diversify within the asset class and beyond the asset class. Consider investing in real estate, ETFs, bonds, and cash.
  • Track investments – Investors need to periodically track their investments to ensure they are on the right track. At the same time, they should not make hasty decisions, as equity investments may often witness short-term underperformance.
  • Review and rebalance – Portfolios require regular tune-ups. Investors must rebalance their portfolios to avoid running at a loss. Some reasons to rebalance may be if an investment goal has been reached, if there is a change in risk tolerance, or if the asset allocation has veered too much toward one asset class.

So, it is important to weigh the pros and cons and then choose your portfolio accordingly.

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