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Navigating Through Investment Risks… A Layman's Perspective on The Risks in Equity Investing...

Navigating Through Investment Risks…

A Layman’s Perspective on The Risks in Equity Investing…

I would like to address this subject keeping in mind one of the most efficient asset classes for wealth creation i.e. Equity (Includes Equity Stocks & Equity Indices).

When investing in equity, one of the most crucial things to understand is Risk. Most individuals hold a somewhat distorted and/or shallow view of Risk. For the ones who look at equity purely as a speculative instrument for making quick money, equity investment, for them is fraught with risks of the extreme kind. However, for the serious investor, who views equity as a long-term wealth creation tool, understanding risk and its impact, will help him apply prudent Risk Management strategies to benefit in the long run.

Broadly put, there are two types of Risks staring at investors in equity investing. These are:

1. Event Linked Risks

2. Asset Linked Risks

Event Linked Risks: Event-linked risks arise out of the various developments (Positive as well as Negative) happening around us and the reactions triggered by these events in the market. These events/developments could be political, social, geo-political, economic, etc. in nature. The last three decades have witnessed several events like The Economic Liberalization, The Harshad Mehta Scam, The Ketan Parekh Scam, The Tech Bubble, The Global Financial Crisis, Change in Political Regimes, Demonetization, GST Implementation, Periodic Policy Announcements (fiscal as well as monetary), Covid Crisis, and the latest being The Russia – Ukraine Conflict. Each of these developments are interpreted by market participants in different ways and to different extremes, thus triggering mild to sharp UPs / DIPs in the markets. However, amidst all these events, the long term story of the economy has remained intact. It therefore comes as little surprise that over the long term, the economy and thus the markets have shown a continually rising trend. A look at the SENSEX chart (below) spanning this three-decade period shows that anyone who would have chosen to invest even passively during this period (and would have stayed invested for long) would have ended up making handsome gains. Active investors with a fundamentally sound portfolio-based-approach and the patience/discipline to stay invested for long would have made a killing.

Event Linked Volatility can thus be best negotiated by staying invested with patience and discipline over a long period of time.

Image: The SENSEX Journey (THREE DECADES of WEALTH CREATION):

 

(Image Source: https://twitter.com/bseindia/status/1352100012281405441)

Asset Linked Risks: Asset Linked Risks in this case refer to the risks that emanate from choosing a particular company for investment. These risks can be further divided into:

1. Liquidity Risk

2. Risk of choosing a Bad Company.

When the stock in consideration is thinly traded on the exchanges, it gives rise to Liquidity Risk. Because of liquidity risk, any sizeable buy/sell transaction in these stocks can cause their prices to move sharply either ways. Liquidity of a stock doesn’t necessarily indicate its quality. In fact, several stocks with great growth potential find themselves marred by liquidity concerns, especially in the initial stages of their growth cycle.

The Risk of Choosing a Bad Company is also a very real threat faced by investors. Despite having done adequate fundamental research before picking a stock, there is still the possibility of this risk creeping into your portfolio.

Asset-linked Risks (Liquidity Risk & Company Specific Risk) can be best managed by creating a strong diversified portfolio with a balanced representation of Large, Mid and Small Cap stocks. This approach seeks to minimize the impact of wrong selection by spreading the risk across the portfolio. It also helps strike a winning balance between Long Term Growth & Stability.

Conclusion: Even the best of analyses could yield disappointing results if they fail to account for these risks and their impact on your investments. Gaining a deeper understanding of how these risks play out will help you navigate through them effectively, thus boosting the performance of your portfolio.

About the author
Deepak Rameshan,
CERTIFIED FINANCIAL PLANNERCM, Dip TD, MMS
Deepak Rameshan is a CFPCM professional, and has been working in the financial services domain for close to 13 years. He holds a Master’s Degree in Management Studies and a Diploma in Training & Development and has been actively engaged in Training & Content Development during this period. As a Personal Finance Enthusiast and an avid researcher of the subject, Deepak has delivered several Investor Awareness Workshops over the years covering areas such as Risk Planning & Insurance, Retirement & Goal planning, Tax Planning and a few other specialized areas. He takes keen interest in writing and has penned numerous articles for this blog, addressing some of the most relevant concerns that individuals face with respect to their finances. “Financial Planning Standards Board Ltd. (FPSB Ltd.) is the proprietor of the CFPCM, CERTIFIED FINANCIAL PLANNERCM and marks outside the United States, including in India, and permits qualified individuals to use these marks to indicate that they have met FPSB Ltd.’s initial and ongoing certification requirements.” Watch this space for more insights on Personal Finance…
Watch this space for more insights on Personal Finance
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