Risk management is a crucial aspect of managing investments, whether it is for managing personal finances or managing a large investment portfolio. The process of identifying, assessing, and prioritizing risks is essential to ensure the safety and security of the investments being managed. Without proper risk management, investments can be exposed to significant losses and volatility in the market, which can have severe repercussions for the long-term health of your portfolio.

Most people spend more time managing smaller risks than required, which has a much bigger impact on their financial well-being, especially in the later years. Even while planning a vacation, we look at potential risks such as country of travel, country specific rules, weather conditions, political scenario, language, culture, and traditions. After identifying these risks, we have mental frameworks for assessing each of these risks. We look at factors like higher probability of snowfall, or a political crisis, or flight disruptions and connectivity issues. We work around these so that we can have a perfect vacation. Similarly, in investing, we need to assess various risks and align our investments to our ultimate objectives.

Why risk management is important?

One of the primary objectives of managing capital is to preserve the principal amount and grow it realistically. By identifying and understanding the potential risks associated with different investment options, investors can implement strategies to minimize the impact of these risks. This involves detailed diversification of portfolio across asset, sectorial, and strategy level. Let’s understand this from the data below : –

• Markets evolve and it’s the prime duty of the investor/fund manager to review and rebalance their portfolio at regular intervals. In the data mentioned above, calculate the impact in the portfolio if the investors are not present in pharma sector in CY2020 or in small/microcap between CY2020- 2023 or having quality strategy in last two years, wherein the value strategy has performed well.
• Effective risk management can also help in optimizing returns. By carefully assessing the potential risks and rewards of different investment opportunities, investors can make informed decisions that have the potential to generate better risk adjusted returns. One of the ways that investors can implement this is by having an asset allocation goal and sticking to it. Diversifying across  uncorrelated and market non-directional strategies (like within equity market – options, long/short, arbitrage etc.) that have long term potential is a great way to achieve this goal.
• Effective risk management is also essential for regulatory compliance. Large financial institutions and investment firms are subject to strict regulations and guidelines related to risk management. These have been developed over the years and are implemented to safeguard the interest of investors. By learning from and implementing robust risk management practices, individual investors can develop a framework for their investments. Avoiding unregulated investment entities, investing in tips by unregistered advisers and over-leveraging the portfolio (directly or through F&O), has caused a lot of pain to most of the investors. Trusting an experienced fund manager with your investment is always advisable for wealth creation.
• A famous quote says, ‘Risk comes from not knowing what you are doing’, it is very crucial for investors to understand this aspect of financial management and imbibe it in their investment philosophy. Ultimately, it’s not only the risk that will help the portfolio to grow, but also the safety and liquidity of the investment (SLR – Safety, Liquidity and Risk). Let compounding, which is also known as the eighth wonder of the world do the rest of the job.