One of the most popular beliefs in investing circles is that if you want to generate high returns on your investment, then you need to take high risks. While this might be true in some cases, it is not entirely true for all people.
The reason is simple – every person has a different definition of risks. Another major concern is putting a number to the risk associated with an investment. While there are numerous financial ratios and experts offering guidance on calculating investment risks, the core aspect considered by most analysts is the volatility in the price of the asset.
Let’s break this down.
If you are investing in a share, then its price changes every minute. Hence, when you are looking for a low-risk investment, you will try to find stocks that don’t have highly volatile prices. But, the problem with such stocks is that since they don’t move much, the returns are fairly low.
On the other hand, if you look at the stock of a small-cap company, then you will find that the percentage increase or decrease in its price is very high. Hence, it offers an opportunity to earn high returns.
Let’s say you decide to buy stocks of ABC Ltd that have high debts. Such companies are known to be high-risk companies for investors.
If high risks equal high returns, then investing in such companies should offer higher returns.
However, if you look at the performance of companies in the past, then you will observe that low-debt companies tend to offer better returns than those with higher debts in the long run.
The high-risk = high returns equation doesn't play out.
Many investors have a simple view of the risk-reward relationship. They believe that if they want to earn a higher return, then they will have to invest in medium-to-high-risk equity mutual funds.
If you look at the example cited above, then one can extrapolate that even in mutual funds, high risk will not always imply high returns.
In fact, you will be surprised to know that some of the low-risk funds offer better returns than their high-risk counterparts.
Check out the Best Low-Risk Mutual Funds to Invest
So, what is the trick? How can you ensure maximum returns with minimum risks? While there is no ‘master key’ to this, here are a few pointers that can help you reduce the overall risk of your mutual fund portfolio:
Remember, every investor has a distinct level of tolerance for investment risks. This can also vary at different stages of your life. Hence, the first thing you must consider is the level of risk you are willing to take.
Think about your financial goals and commitments, and make sure that you draw the line carefully.
There are hundreds of mutual fund schemes to choose from. While your family and friends might recommend certain schemes, it is prudent to research the mutual fund market before making a choice.
Every fund manager tries to offer the best returns to investors while exposing the portfolio to minimise risks. What you need to look for are schemes that suit your risk appetite.
Mutual funds schemes declare the investment risk on the scheme documents. Before choosing a fund based on the riskometer, go through the portfolio and the asset allocation strategy of the fund. This will help you assess if the risks are within your tolerance limits or not.
Also, read up about the fund manager and look at the history of the different funds he/she has managed.
Tax can eat up into your returns if not planned properly. Hence, while calculating returns, always keep the tax rules in mind.
The traditional approach of drawing a direct correlation between risks and rewards might not work in all situations.
Hence, modern investors need to start looking at risks differently. Making an informed decision can help you generate high returns even from low-risk mutual funds.
It is better to avoid the urge to blindly follow the equation of high risks=high returns and make informed investment decisions.
Disclaimer: This blog is solely for educational purposes. The securities/investments quoted here are not recommendatory.