Risk Management is a topic which is mostly discussed at institutional level and most of the strategies are for institutional or large investors. Retail investors should understand the need of risk management and make his / her strategies accordingly .
DEFINE EXACTLY HOW MUCH CAPITAL YOU CAN DEPLOY PRESENTLY WITHOUT BEING STRESSED –
It is very important for a retail investor to understand and define how much capital as a percentage of his net worth he can deploy in the markets without taking undue leverages and stress. Never invest in a market through loans and leverages. While provisioning for future is important , enjoying present life and catering to present urgent needs of the family is also very important. Never forget this. As a thumb rule , a retail investor should ideally deploy such a capital over a period of ten years , which will double his net worth after successfully satisfying all his family’s other needs over that period.
DEFINE YOUR EXPECTED EARNINGS AND TIME FRAME CLEARLY –
If we look at Nifty CAGR since inception , it is about 12.2%. If we look at secular compounding stories over a period of last 10 years HDFC Bank has a CAGR of 17% , TCS at 17 %, INFI at 18% , Page Industries at 29%, Asian Paints at 22% , Pidilite at 27%, HUL at 17% and Nestle at 15%.
If we analyse the historical data , we can say that over a period of 10 years , a retail investor can set a target of about 17-18% CAGR. The real problem for a retail investor lies here as they invest in equity markets in expectancy of multibagger returns . But actually investments in equity markets are great compounders over a longer time period.
If the retail investor understands this fact , ignores the multibagger stories and returns, concentrates on fundamentally strong companies and expects a CAGR of 17-18% , more than half the risk is eliminated already.
STOCK SELECTION –
Large cap , mid cap , small cap approach does not work.
One common mistake the retail investors make while designing a portfolio is adopting a flexicap approach.Retail investors often feel that large caps will give them around 10-12% , mid-caps around 15-20% and small caps around 20-30% returns over a longer period and they try to mix these companies in their portfolio, assigning them different weightages and expect an effective CAGR of about 17-18% on portfolio basis. But , usually , this approach does not work . The best thing for retail investors is – once they fix their expected returns at around 17-18% , they should focus on companies which have historically and consistently delivered similar kind of returns irrespective of the market cap.
Number of portfolio companies —
Another big question for the retail investors is how many companies I should hold in my portfolio and what should be the weightage.
The answer to this question lies again in the earlier part. If you’ve found 10 companies which have historically given similar kind of returns as your expected returns , then you can hold all ten of them with equal weightage. Try to keep things simple. Don’t get into concentrated vs. diversified portfolios debate.
Sectoral Diversification –
From retail investor’s point of view ,financials ,IT ,consumer durables and staples and pharma are the core sectors as these companies have sizable media presence , investors can see their products in the market and this helps in developing convictions and holding the stocks over a longer period of time. A a thumb rule , one should avoid more than 30% allocation to an individual sector in long term portfolios.
WHEN AND HOW TO BUY ?
Once we shortlist the stocks , the next phase is to buy. Try not to be very smart and predict the bottom. If you have a one time capital to invest , then divide it into 2 -3 equal parts and buy the desired stocks in a staggered manner over a period of around 2-6 months. If you’re salaried , then you can buy the stocks on a monthly basis.
MONTORING AND DEPLOYING INCREMENTAL CAPITAL –
Once the portfolio is in place, regular monitoring is crucial . You can read news and stay updated on social media about your portfolio companies . But, actual transactions should be carried out in a disciplined manner , say , on quarterly basis , neglecting daily noise . Incremental capital ideally should be deployed in the same companies unless you get another compelling opportunity.
EXITS –
Once the portfolio attains desired returns over a planned period , then you should liquify the portfolio . If you want to re-deploy the cash into markets , you should go through the entire discussed procedure again .
If during holding period , some of the portfolio companies fall or do not generate expected returns , then we should keep a strict stop loss and exit those companies . For a portfolio whose objective is around 17-18% returns over a 10 year period , one of the portfolio companies correcting 30% in a year (assuming overall markets are sideways or with positive bias) is not a good sign .
If during holding period , some of the portfolio companies generate more returns than expected , then we should increase the allocation to these companies. But it is also advisable not to exceed around 20% allocation to an individual company.
The information provided by Finance Voyager is for information purposes only and is not intended for advice. Finance Voyager also does not make any recommendation or endorsement as to any investment, advisor or other service or product. The information is only for educational purposes and not buy or sell recommendations.
Trually very educative for me