6 Ways to Reduce Stock Market Risks

Investors are always worried about risks facing their portfolios. Many investors lose money due to these risks. Though there is nothing like a risk-free investment but there are definitely some smart ways to reduce the risk and earn money in stock market.

In our previous blog on ‘Major Types of Investment Risks for Stock Investors’, we learnt about the different types of investment risks that surround an investor. In this blog, let us understand the ways to reduce or manage stock market risks. These risk reduction strategies will help you protect your portfolio.

How to Reduce Risk When Investing In Stock Market

• Diversification of Portfolio

Diversification of shares in your portfolio reduces the risk by spreading it across to a variety of shares. You can diversify your portfolio by keeping shares of different industry sectors or different company sizes, etc.

It is a good risk reduction strategy to invest in varying industry sectors like pharmaceutical sector, real estate sector, FMCG sector, banking sector, etc. So if one industry sector in your portfolio is not doing well, companies in other industry sector may be doing well. Like for example – If banking sector is facing a downside, it may be possible that real estate sector is booming.

Similarly, you should invest in companies of different sizes. Reason being, small and relatively new companies have ahigher potential for growth but at the same time are risky. On the contrary, large companies are more stable and have good performance record making them less risky. So it is advisable to have a mix of different company sizes.

• Stay Invested for Long Term

Be a long term investor, instead of being a short-term speculator. Buying stock and holding it only for a few hours or weeks is not investing, it is gambling. Moreover, the stock market is subject to short term fluctuations. Short term trading is risky and there are chances that you may experience a major fall in the price of your holdings during short-term.

On the contrary, long term investments are safe and yield better returns. The longer your investment horizon, the more likely the stock market is to rise. A long term investor is not affected by short term fluctuations and bear market.

• Seek Advice

You are inviting risk by investing in the stock market without having knowledge of the same. If you invest without knowledge, you are gambling and it can result in losses. Investing in the stock market requires agood understanding of how the market works, what triggers the prices of stocks and how an investment strategy works. If you lack the knowledge, you must seek advice from qualified advisors who can guide you on investment strategy keeping in mind your risk tolerance.

• Analyse Company’s Background and Performance

It is extremely important to research about the company you are going to invest in. You must look at the companies past performance, investment history, debt load, earnings growth, management competency and lot many other factors. Also, analyse the Price Earnings ratio (P/E ratio) of the company to measure the market value of a stock relative to its earnings. Pick stocks with lower P/E ratio as they are less risky.

• Determine Your Risk Tolerance

Every investment carries some level of risk. Though it is impossible to eliminate the risk completely, but you can definitely reduce the risk. Determine your risk tolerance by analysing two factors - your net worth and risk capital. Net worth is your assets minus your liabilities. Risk capital is the amount of loss you can bear on an investment without impacting your lifestyle. If your net worth is high and risk capital is substantial, you can have a higher risk tolerance. Similarly, with lower net worth and risk capital, you should adopt a conservative approach and go for lower risk tolerance.

• Monitor Your Investments Regularly

Be watchful of your investments. Monitor and consider reallocating your investments regularly. Allocation of investments depends on factors like your age, investment horizon, risk appetite, investment goals, etc. Asset allocation not only helps in maintaining the balance in your portfolio but also helps to achieve your goals. Let’s say if you have decided to invest 50% of your capital in large cap stocks, 25% in small cap stocks and 25% in short term bonds. Then once a year you should evaluate your holdings and rebalance your portfolio to bring back the decided asset allocation.

These are few effective ways to reduce stock market risks. Once you learn the tricks to avoid risks, your chances of losing money in stock market drastically reduce. So before you think of returns, figure out the risk and determine your risk tolerance.

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