‘are subject to market risks, please read the offer document carefully before ’ goes the oft-repeated statement. Like the warnings on cigarette packs, investors tend to ignore this caution. But it is important that as a investor, you are aware of the risks that you are taking.
The market risks referred to in the above statement are of two types:
- Risks that you as an investor can do nothing about. Called Systematic risks, these could be political factors, exchange rate fluctuations or even bad weather. Contrary to what you may have heard, these are difficult, if not impossible to predict or avoid.
- Risks that you can manage by liquidity risk. strategies: In a , these risks are taken care of by your but you should be aware of them nonetheless. We can categorize these into 3 broad types – business risk, concentration risk and
A sudden strike in the auto sector mutual funds is an example of business risk. Poor financial performance of a company is another example. A mitigates this by diversifying across companies and sectors.
Concentration risk comes in when atoo large a proportion of its money in a single stock or sector. Sector , by definition, suffer from concentration risk because they in a single sector.
Liquidity risk arises if a cannot quickly convert its into cash, either in response to a redemption demand by investors or as part of . in small cap stocks face this risk.
What can you do about this, now that you know?
Be careful while picking. Ensure that you in large well- . If you in specific sector or small/mid cap , do it with full knowledge of attendant risks.
In our experience,managers do a good job of managing risk. The biggest risk to an individual investor in comes from faulty practices. And there is a lot you can do about it.
Reduce Risk by Reducing Mistakes
by definition involves exposing yourself to ‘risk’. The best you can is to minimize risk. Having decided to via , and not directly into stocks, is step 1 of minimizing risk. You are saying, “Let me entrust the task of to people more capable than me, and who do it fulltime”.
But most investors still make lots of simple errors whilein . Let’s look at common errors, so can you avoid them.
1. Investing with expectation of very high returns
In an earlier section we talked about what the long term expected returns from variousclasses are. However, we continue to see investors choose with expectation of unreasonable (40-50%) returns. This is just not going to happen and in an attempt to generate that return, you are likely to be misled into in that have shown a temporary blip in performance.
Look at returns of how to choose mutual funds?over a minimum 5 year period. A 2-3% outperformance for equities and a 0.5-1% outperformance in debt funds is the best you can expect and you should be aware of that. If you have any doubts, please refer to:
2. Investing without understanding of underlying investments
You already know that allare not the same. Depending on which class and category of they in, you will get different returns with different behaviours. Debt funds offer lower but steadier return. offer higher but more volatile return.
Tax saving( ) are essentially and have the same return and risk profile.
With this course, you should have enough knowledge to understand how the returns from a specific type ofwill vary. You can refresh your learning here: How many type of are there?
3. Investing in NFOs “at par” or funds with “low” NAV
Some investors believe lower the Net Asset Value (NAV) of a , the better value it provides. In other words, a with an NAV of Rs 20 is ”cheaper” than another with an NAV of Rs 30. This belief is, perhaps, a mistaken application of the value- principles of equity .
So, often such investors,into a New Offering (NFO) at par value or Rs 10, thinking they are buying value.
But as you already know, from this course, that it makes no difference whether the NAV of ais high or low. In fact, older , with a longer track record, will always have high NAV and you are better off choosing those rather than a new with lower NAV but no track record.
4. Investing for “dividends”
We often see advertisements bydeclaring . Some investors are misled by these and think higher reflect good performance. In the case of , declaration is nothing more than a book entry. are not interest but repayment of capital. Therefore the fund’s NAV falls to the extent the are paid out to its unit holders. In fact, a growth option where you withdraw the money when YOU need it is better for you from a tax perspective.
Understanding market risk is important but if you have chosen theclass that best meets your objectives, you can trust the to manage the market risk for you.
As an investor, you should focus on things you can control which are:
- choosing the right
- following the correct process for
- reviewing your every year