The key to making money is to eliminate all risks that come with investing in the stock market. To be honest, there is no way to eliminate the risk entirely. But we sure can adopt strategies to minimize them.
So, what kind of risks come with stock investing.
Well, losing your entire sum of money: that’s your obvious no 1 risk.
But let’s get serious. After discussing with my friends and neighbors I realized people are worried about volatility. It’s their No.1 fear. The stocks markets are too volatile they say. And therefore, don’t want to invest in the stock markets.
What they don’t know is that there are ways to reduce the volatility risk in your investment portfolio. Fund managers have been doing it forever. And so have the most successful investors across the globe. These very risk minimizing strategies are what sets them apart from the rest:
1. Diversify! Diversify! Diversify!
Afterall, it's the only free lunch offered by the investment world. And perhaps one of the most powerful tools successful investors have by their side.
Diversification is the simple act of developing a mix of investments that are not related to one another. Like owning a variety of stocks, bonds and other assets (Gold etc).
A well-diversified portfolio not only delivers growth but also maintains a level of risk that is conducive to the investor. It may make it easier for investors to stick to their investment plans in volatile times.
Keep in mind that diversification does not guarantee gains, or that you won’t experience a loss. It just aims to provide a simple trade-off between risks and rewards(returns).
You can not only diversify among stocks, bonds, and cash, but also within those categories. Consider diversifying your stock exposure across regions, sectors, investment styles (value, blend, growth), and size (small, mid, & large-cap stocks).
For bonds, consider diversifying across different credit qualities, maturities, and issuers.
What you chose will ultimately be determined by your risk taking ability and return expectations.
2. Invest for the long-term
'You are better off investing for the long term in the stock market.’
‘Over the long term, the stock market is likely to generate a 13-15% return.’
We come across these statements over and over again. But how long is ‘long term’?
From a taxation purpose, investing in stocks and equity mutual funds for up to 1 year is considered long term. But that’s not what the investor gurus are referring to.
Long-term can be defined in 2 simple ways:
Staying invested in the market for a period of 5 years at least OR
Sticking to a particular fund or even stock over their entire lifetime.
The stock market is flooded with volatility risk. To combat it you have to invest for the long term. This will allow your investments to grow and ride the ups and downs of the markets.
It’s important to understand that a good investment strategy takes time to play out and can help you ride out the peaks and valleys of the market.
Start by asking yourself how much of your investment portfolio do you want to commit and for how long? Find the right balance for you and your situation. The key is to have clear goals in mind. So you can match them to your investments.
3. Let your investment goals define your portfolio mix
Different investors react differently to stock market corrections. A conservative investor will worry and withdraw his investment from the market. Whereas, some active investors will consider it an opportunity to take advantage of the correction.
Whatever you chose to do, ensure that it reflects your ultimate financial goals. Be it long term or short term.
Any kind of volatility in the markets should not deter you from your goals. Adjusting your financial plans to reflect the current market condition is only a recipe for disaster. Successful investors understand that. And hence develop an investment mix that works well for them in good times and in bad.
So, if you find yourself constantly worried about the volatility in the markets develop a portfolio with less volatile investments.
4. Focus on valuations: buy wonderful companies at fair prices
Finding a good company is only winning half the battle. The other half is all about buying it at the right price.
Do a quick ratio analysis. Compare it with relevant peers in the market. All this effort will never go wasted. And it is a whole lot easier than losing your hard-earned money.
Buy only when you feel you can build a margin of safety. For example, buy a company at a discount to its fair value. So, if it doesn’t perform as expected you have a built-in cushion. Yes, the stock will only grow at a normal pace but you’re better off investing in a stock where you find deep value.
Don’t let the volatile markets scare you away. They are an excellent tool for building wealth over the long-term. As mentioned before, we cannot eliminate it completely from our investment portfolio. But we sure can build a resilient one by incorporating these guidelines in it.
Click here for the latest coronavirus news and updates. According to experts, people over 60 and those who are immunocompromised continue to be the most at risk. If you have questions, please refer to the WHO’s resource guides.