Success in investing has nothing to do with your intelligence. You need the temperament to control the urges that get other people into trouble in investing. As share prices soar to new highs daily, your writer is reminded of Warren Buffett again. At such dizzy heights, there is a lot of risk lurking somewhere. Despite things going well for India’s surging economy and stock markets, that is. As an investor, you are better off prepared. Knowledge is the only weapon that can prepare you for eventual risk events. If you are aware of the risks, you can manage them.
How to define risks
There are internal and external risks associated with your finances. Your temperament is an internal risk. If the opinions of others sway you, you are likely to make the same mistakes as them. You need to err on the side of knowledge. Get into a habit of reading up on things that people recommend. You can cross-check the information and make decisions based on your research. Then, there are many external factors. Financial markets go through cycles. Share prices do not move up in a straight line. If they are at their peak, there is a good chance that they may fall from there or stagnate at those levels. Putting a lot of money in the market can be risky at that time. Sebi recently cautioned mutual funds on risks in launching mid-cap and small-cap schemes when such stocks are trading at record-high prices.
Inflation plays a significant role in the value of money that you hold in the future. Try to learn more about the impact of persistent inflation on your money. You must read the inflation outlook published every two months by the Reserve Bank of India. While you can read a lot more about the significant picture factors like economic growth, consumer demand, government finances and policies, you can start tracking some lead indicators.
Stock market prices today reflect tomorrow’s profits. If they fall for some reason, prospects for profits are not so great. Rising prices affect businesses, too. The moment you notice prices of essentials and other services are rising, you should take note. In a high-inflation environment, the profits of businesses get squeezed as they cannot pass on rising input costs to customers due to competition.
Understanding your ability to withstand risk is the next step. If you speak to any professional advisor, they will talk about your risk appetite before telling you about investing. It is usually a function of your ability to withstand losses. That comes from your confidence in your future income. If you believe there is a limited risk to your future income, you can withstand shocks and have a high-risk appetite. However, if your confidence is dodgy about your future earnings, you may struggle in a downturn if you take risks.
In most cases, Indian households put their surplus money into real estate and gold. According to the RBI data, only 4.7% of household assets are allocated to equity in India. It is four times higher in America. That shows that most Indian households have a low-risk appetite or need something tangible.
Investing is for the long-term
A fundamental principle of mitigating risk is investing regularly and holding your investment long-term.
That applies mainly to equity assets that carry an immediate risk of loss. However, you need to ignore the noise about booking profits or losses. You must invest in equities long-term and benefit from the potential upside in capital gains. Mutual funds in India offer a systematic investment plan in various schemes that own multiple asset classes. You can minimize the risk factor in your investment by allocating your surplus money across large-cap, mid-cap and small-cap companies.
You can also use hybrid schemes to lower the risk to your portfolio. Your equity investment requires 12-15 years to create any meaningful wealth. Short-term investing in equities directly or indirectly is akin to trading.
Rajas Kelkar
(The author is editor-in-chief at www.moneyminute.in)