HOW TO REDUCE RISK IN INVESTMENT PORTFOLIO ??

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Indian equity markets have lost momentum over the past year. It's easy to speculate on reasons for the drop and wonder if we should stop investing or withdraw money (we started getting emails like this!). However, the development of a simple, market-independent strategy based on systematic risk reduction would be much more effective.

Why? We have no control over market returns. Yes, asset allocation with regular rebalancing and diversification within each asset class will reduce this uncertainty, but we are still slaves to market turbulence.

So, a market-agnostic investment strategy aims to ensure that the current corpus is above or close to the required target corpus (at the time of review) at any point in the investment journey.

The advantages are apparent. We invest systematically and manage risk in the portfolio regardless of market conditions. There is no need to follow market news or market ratings. No need to take media pundits seriously and worry about what to do. Once set up, systematic management can be run on autopilot with no more than 30 minutes of portfolio review once a year!

How to systematically reduce portfolio risk ??

Here are few steps

• Make it clear when you need the money. This may seem trivial, but it is the most important step in the investment process. It decides how much risk we can take and therefore the asset allocation.
• Have reasonable return expectations. For example, for long-term goals, one should not expect more than 9-10% equity after tax. Even today, it's difficult to get 7% after-tax from fixed income instruments. So after a few years this will be no more than 5-6%.
• Decide on the initial asset allocation. For a goal more than a decade away, 50% stocks and 50% fixed income is just about perfect. In the best case you can increase the equity to 60%, with higher values ​​the risk is too high.
• This is the stage where you usually start investing systematically. However, there is a catch, the key step is missing. Market returns are unknown and uncertain. To ensure we reach our target corpus, no matter how the stock markets perform, we need a variable asset allocation plan. How will we reduce equity exposure so that the total corpus does not deviate too much from the target corpus? The target corpus and the investment sum are to be calculated on the basis of this asset allocation plan.
• Equity exposure may be reduced gradually or continuously. In any case, this must be done in good time before the target date.
• You can now invest systematically. The flip side of the coin is that systematic risk management is already planned in the above step. We only need to review the portfolio once a year and review and rebalance our actual asset allocation as needed to bring it in line with expected values ​​under the variable asset allocation plan. Using simple products like index funds makes portfolio review even easier.
• If needed, gains can be reallocated from equity to debt after a huge market upturn (e.g. March 2021 to September 2022). This further reduces the portfolio risk.