Managing risks is not extremely difficult as it seems. The key to risk management is splitting your investment into different risk categories and knowing when to enter and exit the marketplace.
Many youngsters enter the world of equity buying without a clue about what they want to buy. Usually the first buy is on the recommendation of a relative or a friend. Though it is fine to invest with ideas from known people, it is better to learn the ropes yourself. So, how do you understand the world of high finance without a primary knowledge of commerce? Well, it is not so difficult as it seems.
It is said that the wish to find gold makes men go around the world. So, it is not unusual for investors to learn the fundamentals of investing and buying equity as they start to invest. Even if you invest in mutual funds, you would need the knowledge to understand which mutual funds are working better for you and which are not.
How to manage risks
Let us say that a young 20-year-old investor invests 60% of her/his savings in equity or stocks. This is a relatively high-risk high-gain area where the person could make a lot of money or lose some. So, the ideal option to lower risks would be to invest the balance 20% in mutual funds and 20% in bonds. Risk management looks like an esoteric term but has very simple fundamentals. A method to split your investment into high-risk and low-risk investments is the first basic step of risk management.
So why are risks in stocks higher than that of a mutual fund? Because the mutual fund is a basket of stocks and not one single stock. So, if the value of one stock drops, the other compensates for it. Hence a mutual fund is a relatively low-risk investment where you do not buy one stock but a fund that invests in multiple stocks. But whereas the chances of losses while buying a mutual fund is lower, the chances of high gains are also feeble.
Bonds or debentures or fixed deposits have low returns. Some of the fixed deposits are issued by banks where you cannot lose money but the interest paid is low. Then there are tax-free bonds usually issued by public sectors that are always a great saving option for tax payers.
Entry time and exit time is important
Investing in stocks is basically a matter of timing. Warren Buffet, the world’s biggest and most successful investor, believes in long-term investment with planned entry and exit strategy. Though you could be a novice with your first investment, it is prudent to start thinking like Buffet. Think of long-term investments initially. Only pros can really make short term profits from volatile stocks, so avoid them before you have learnt the basics.
The only reason you could lose money in the stock market is because you have not invested in the right stocks or have got your timing of exit and entry wrong. So, create your strategy first. Study the stock movement for the last six months before you invest in it. Also go through its annual results of the past year. This will give you a basic understanding of the stock you are investing in.
Fundamental and technical analysis
Similarly, for mutual funds or bonds, there are basically two things that require study before investment. One is the fundamentals of the company where you are investing in, more so for stocks than bonds. Here you start to understand the earnings of the company and the returns on investment and other financial ratios that affect a stock performance.
Another is the price movement of the stocks or bonds that you would want to invest in. Here you do a trend analysis of the stock price movement and the industry type. You also understand the market movements the upswings, downswings and the effect of volatility on stock prices. The first analysis or the tracking of the financial health of the company is called the fundamental analysis and the second part or price tracking is called the technical analysis. We will tell you more about the same in the coming days. Keep watching this space.