Stock market investing and trading are fraught with risks. Before you learn to take risks, you must learn to know about them.
While investing, you face systemic and market risks due to human biases. Systemic risks are associated with the stock market or the banking system. Stock markets are expected to ensure the safety of the trading settlement cycle. That means buyers must get shares in their demat account on the settlement day, and sellers must get the money. If a stock market or the banking system is hacked, that can disrupt the settlement cycle. It is an example of systemic risk.
The guaranteed settlement does not mean guaranteed returns. You still face other risks like those associated with the financials of companies you buy or sell shares into directly or through mutual funds. Your mutual fund could be poorly managed, or you may buy at a time when share prices are at their peak. Even your fixed-income investments face an interest rate risk. If inflation rises in an economy, you have to pay more for loans. You must also switch from low-return fixed-income assets to those offering a higher revised interest rate. These are some market risks.
The third type of risk associated with your investment is biases. These are associated with human behaviour. You may follow recently occurred events to determine future investments. A loss incurred in the past could stop you from making smart investments in the future. Another example of a human bias is herd mentality. You could join the chorus of people who insist on investing in a particular company based on rumours. Company fundamentals matter to your investment in the stock market.
Indian households are, by and large, risk-averse. That is reflected in the relatively low participation in the stock market directly or indirectly through mutual funds. While in rich countries, every other individual is a mutual fund owner and every third a stock investor, that percentage is barely scratching the surface in India.
Yet, there are many instances when many end up buying into assets they are unaware of. Cryptocurrencies and related assets are an example. People flush with surplus cash rushed to buy crypto assets at the cycle’s peak. They ended up burning their fingers. Something similar happens when you get attracted to the news about stock market rallies. Retail investors are usually the last to participate in a stock market rally. They buy equity assets at the peak of the stock market cycle. As that market cycle turns, first-timers make a loss, and they decide to stay out of the investing or the trading game.
When to take risks
Risk appetite is your ability to withstand a loss. You can take a risk if you are sure of your future income. If you know that you are likely to do better in life and earn more, you are in a better position to take the risk. Your age is not a problem if you know about your guaranteed income through rent or savings. That does not mean you should bet your retirement savings on investing in the stock market. If you are likely to settle on a pension lower than your last payment, you must use your savings through provident and pension funds to buy an annuity plan.
If you are young, you can determine a portion of your income as risk money. That does not mean you buy crypto assets or real estate in places where you cannot travel often. You can invest that into equity assets and build a diverse portfolio. As stock markets go through multiple cycles, you can ride through them to create steady wealth. Diversification allows you to mitigate risks.
Importance of knowledge
The other way to lower the risk element in your investments is by gaining knowledge. There is nothing like being aware. If you are an investor and wish to remain one, you must give yourself daily time to gather knowledge. Spending a few minutes understanding factors that influence your investments can only help you build confidence and minimise the impact of market cycles.
Build a diverse portfolio
If you are young, you can determine a portion of your income as risk money. That does not mean you buy crypto assets or real estate in places where you cannot travel often. You can invest that into equity assets and build a diverse portfolio.
Rajas Kelkar
(The author is editor-in-chief at www.moneyminute.in)