Equity Investments have always been associated with high-risk quotient. A general formula that we have always known with respect to investment is; the higher the risk, the more the chances of earning. For example: a fund will offer you a 25% return with the risk quotient entailing to be 5% and another fund may offer a 50% return with a 100% risk quotient. Now, it depends on one’s mettle to take risks that will determine the investments and returns. While many may opt for fixed income investments like bonds and fixed income funds, investment in equities has grabbed a lot of attention. While equities may seem to be risky on a short-term basis, the degree of risk reduces when you have a long-term approach.
While equity investments may seem highly attractive and rewarding, there are a few risks that one must be cautious about

:
1. Their dependence on the economy:
No matter how good a company, its growth will depend on the growth of the economy. There is a domino effect felt in the growth of the economy depending on the surge or plunge that an economy undergoes. These risks are manifested in components like GDP growth, balance of payment positions, inflation, interest rates, credit growth, etc. Sectors including infrastructure, services, and manufacturing are the ones that fizzle out during a sluggish economy.
2. Industry Risk:
A company’s growth will be in sync with the industry’s robustness to an extent. There are a few exceptional cases where a company may perform irrespective of that industry going through a bad phase. The present era may be inclined towards technology, which might make technology products a hit. Industry segments that have attained a maturity stage may only generate limited rewards. On the other hand, few industries walking on the eggshells may trigger losses or falling gains. Similarly, one needs to understand that every industry goes through a cyclical growth.
3. Management Risk:
Don’t you judge a company by its CEO? A management team will hold the whip hand to formulate strategies that will make or break the company. Hence, quality of management is one thing that an investor must assess before banking on it. There are times when the announcement of a single person joining the company may lead to a boom and vice versa.
4. Company level risks: The operating conditions of a company and the variability will act as a catalyst influencing operating income. There are two broad categories including: Internal and external. Internal risks refer to the company’s operation and external risks cater to operating conditions that is beyond the control of the company.
5. Financial risks: The way a company handles its finances i.e. activities like borrowing, creating fixed payment obligations in the form of interest, will all play a pivotal role in deciding the company’s financial stature.
6. Interest rate: The fluctuations in interest rate owing to the volatility of the future market values and the future income generated pave way for interest rate risks. The increase in interest rate will consequently increase the cost of borrowing which will trigger an increase in the prices of products that will detrimentally affect its sales. A mounting interest rate will affect the company’s earning with its effect felt on the share price.
7. Inflation risk: Inflation can have a negative effect on a company in numerous ways be it with respect to wage hikes, magnified corporate profits owing to an overvaluation of closed inventory that makes the company bear the brunt of high taxes.

How To Alleviate The Risks Involved in Equity Investing?

The art of diversification can enable one to alleviate the maximum amount of risks involved in investments. Experts and analysts often say that it is wise to invest in different companies from different backgrounds. Investing a whopping amount in one company will make you susceptible to high risks. Instead, small investments in different companies will safeguard you from company specific risks. With more companies being added to your investment basket, the spectrum of risk reduces, as you are not solely dependent on a company. The same is the case with sector or an industry, or an economy. Investment across sectors and industries will limit the amount of risks in case a particular sector or industry does not perform well. There are bleak chances that a downturn will affect all sectors and industries, which mean that you will play safe, even during adverse conditions.
While this tool of diversification can reduce the spectrum of risks, equity investments will always pose certain risks that one cannot detach from it. It is not possible for one to do away with systematic risk like interest rates risk and inflation rate risk. By extending the duration and diversifying your investment i.e. proper money management, the risk intensity reduces largely, paving way for healthy investing. Like it is said, managing money requires more skill than making it.

About Kotak Securities:
Kotak Securities is one of India’s share broking firm offering demat accounts, mutual fund and IPO investing service’s along with a research division specializing in Sectoral Research and Company Specific Equity Research. Express your views on their Facebook Page and Twitter Handle (@KotakSecurities) or you can also visit KotakSecurities.com for more information.

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