“You get recessions, you have stock market declines. If you don't understand that's going to happen, then you're not ready, you won't do well in the markets” - Peter Lynch

Investing in stocks can help you make a lot of money. This is the ideology that attracts most investors to the stock market. There are multiple success stories of individuals who started with nothing and have built an empire just by investing in stocks. But for every success story, there is also the investor who quit at the wrong time.

Getting inspired is alright and taking the first step towards investing in stocks to grow your money is necessary. However, the problem arises when investors enter the stock market with unrealistic expectations. If an investor does not understand the market dynamics and does not account for risk, getting in at a unfavourable time can cause immense disappointment.

Investing is not all fun and games

Look at the journey of the sensex, there are 18 instances of more than 10% correction in the 16 year history.

There is a expectation mismatch

Short term and even longer corrections are normal in investing and when the broad market is underperforming, expecting high returns is unreasonable. There’s no future for a investor who denies the existence of risk. To be a successful long term investor, be aware of the risks and the rewards that come with risk.

What are the types of Risks in Investing?

While, investment risk is the exposure of an investment opportunity where loss of capital or downturn might be factored in. Investment risk is still a broad term but can be understood when broken down into the parts, i.e Systematic & Unsystematic Risk.

Systematic Risk

Inherent risks in the stock market are known as systematic risks. These risks affect the whole market. Because they affect the entire asset class, they're also known as "non-diversifiable risk" or "market risks."

External factors such as the present geo-political situation, monetary policy changes, and natural disasters are common causes of these risks. COVID-19, for example, is a systematic risk since it has an impact on the entire stock market & these risks are non-diversifiable as a company can not control, avoid or minimise these risks.

Unsystematic Risks

Unsystematic risks are specific & diversifiable risks that are peculiar to a particular company or industry. These dangers develop as a result of a variety of internal and external causes that influence only the specific business and not the entire market. Systematic risks have components such as Business Risk & Financial Risk.

Benefits of Risk Management

Risk management is crucial when investing money in stocks because it helps investors protect their capital and make more informed decisions. Here are some of the key benefits of risk management in stock investing:

1. Capital Preservation: Effective risk management strategies aim to protect your capital from significant losses. By identifying and mitigating risks, you reduce the potential for catastrophic declines in the value of your investment portfolio.

2. Reduced Emotional Stress: Risk management encourages discipline and helps investors avoid impulsive decisions based on fear or greed. This can reduce emotional stress and prevent costly mistakes driven by emotional reactions to market fluctuations.

3. Improved Decision-Making: Risk management involves a systematic approach to assessing and mitigating risks. This leads to more thoughtful and informed investment decisions, based on a comprehensive understanding of potential threats to your portfolio.

4. Consistent Returns: Implementing risk management strategies can lead to more consistent returns over time. By avoiding steep losses during market downturns, you maintain a more stable and predictable growth trajectory for your investments.

5. Diversification: Diversifying your portfolio across different asset classes, sectors, and individual stocks is a fundamental risk management technique. It spreads risk and reduces the impact of poor performance in any single investment on your overall portfolio.

6. Tailored Risk Tolerance: Risk management allows you to align your investments with your risk tolerance and financial goals. You can tailor your portfolio to match your comfort level with risk, ensuring you are not taking on more risk than you can handle.

7. Protection Against Black Swan Events: Risk management prepares you for unexpected and extreme market events (known as "black swan" events). While you cannot predict these events, prudent risk management can help mitigate their impact on your portfolio.

8. Long-Term Success: Investing in stocks often involves a long-term horizon. Effective risk management helps you stay invested through market fluctuations, allowing your investments to compound over time without being derailed by severe losses.

9. Rebalancing Opportunities: As part of risk management, periodic portfolio rebalancing can be employed. This involves selling assets that have appreciated and buying assets that have underperformed to return your portfolio to its target allocation. This "sell high, buy low" strategy locks in gains and potentially positions you for future gains.

All in all, risk management is not just about avoiding losses but also about optimizing your investment strategy to achieve your financial goals while staying within your risk tolerance. It's an integral part of responsible and successful stock investing.

Risk Management Strategy and Methods: How do we at Wright Research handle Risk?

We use quite a few tools to handle risk:

• Regime Modeling based Dynamic Adaptiveness

• Asset Allocation or Diversification

• Deallocation in extreme events

Regime Modeling based Dynamic Adaptiveness

The core of our ethos contains a regime model that uses Artificial Intelligence to forecast the next month in the market. Is it bullish or bearing?

Asset Allocation or Diversification

We change our asset allocation to make sense of the volatility and switch to safer havens of bonds and gold ETFs.

Deallocation in extreme events

We also have a deallocation policy that helps us switch to cash when the markets are precarious. This improves long term performance.

What you can do now to make the most of the market is SIP! Rupee cost averaging or buying regularly at all levels can give you a much better entry point.

Scenario Analysis and Expectations

Let’s analyze our top portfolios and see how they work in different scenarios.

The Momentum stocks are high risk stocks. They crash when markets are crashing. But with our strong risk management we deallocate and adjust dynamically to minimize losses.

The expectations from these portfolios are based on purely data driven numbers, which makes us confident about the long term performance.

The Multi Factor Portfolios are more conservative and see lower drawdowns. With our strong risk management we deallocate to bonds, gold and adjust sectors dynamically to minimize losses.

The expectations from these portfolios are based on purely data driven numbers, which makes us confident about the long term performance.

FAQs:

1. Why is risk management important for investors?

Risk management is crucial for investors because it helps protect their capital and achieve their financial goals with a higher level of confidence. It allows investors to identify, assess, and mitigate potential risks associated with their investments, leading to more informed decisions and better outcomes.

2. How do I assess my risk tolerance?

You can assess your risk tolerance by considering factors such as your financial goals, time horizon, and willingness and ability to endure market fluctuations. Many financial institutions and online tools offer risk tolerance questionnaires that help gauge your comfort level with different levels of risk.

3. Can risk management enhance my investment returns?

While risk management's primary goal is to protect capital, it can indirectly enhance investment returns by preventing significant losses. By managing risk effectively, you can stay invested during market downturns and avoid the need to recover from substantial losses, potentially leading to more consistent long-term returns.

4. Are there risk management tools or software available for investors?

Yes, there are various risk management tools and software available for investors. These tools often include portfolio analysis software, risk assessment questionnaires, and asset allocation calculators. Online platforms like Wright Research offer risk management features to help investors diversify their portfolios.

5. Can risk management help during market volatility?

Yes, risk management is particularly valuable during market volatility. It helps investors make rational decisions in the face of uncertainty, reduce the impact of market swings, and avoid panic-driven actions. Tools like stop-loss orders and portfolio diversification can be especially helpful in volatile markets.

6. How often should I review and adjust my risk management strategy?

The frequency of reviewing and adjusting your risk management strategy can vary based on your circumstances and market conditions. However, it's advisable to regularly revisit your strategy at least annually or whenever significant life events occur, such as changes in financial goals, employment, or personal circumstances. Additionally, consider reviewing your strategy during major shifts in market conditions or when you experience substantial changes in your risk tolerance.