Introduction
Taking investment decisions in financial planning is a crucial and important step in life. The success of an investment portfolio lies in the diversification of assets and taking effective steps to manage portfolio risk. Aligning towards products like ULIP policy (Unit Linked Insurance Plan) will be advantageous. When such precautionary steps are taken at the initial stages, you can avoid an unnecessary financial crisis. Here is a complete guide on investment portfolio risk.
What is Investment Portfolio Risk?
Investment Portfolio Risk is the probability or chance for the diversified or combination of assets you possess to fail in meeting their financial obligations. There are different types of risk in investment. Some of them are as follows:
- Liquidity risk - When the investment cannot be converted to cash for meeting short term obligations.
- Default risk - When the investment falls due to a business failure corresponding to the asset.
- Political and market risk - When political announcements influence economic conditions, causing price fluctuations in stocks and other investment instruments in the market. It may also be linked to inflation and interest rates.
- Concentration risk - It refers to the concentration of few assets/stocks/securities in a portfolio. Portfolio should be adequately diversified across different asset classes and securities within each asset class.
What determines risk in a portfolio?
The proportion of different types of assets and the extent to which they are vulnerable to risk will contribute to the overall measure. To determine risk in a portfolio, you have to analyse your financial stability and the steady income flow to understand how much money you can afford to experiment and lose in an investment. If you lose more than a limit, you will be driven to take irrational decisions that might prove detrimental. Based on your risk tolerance, investment risk management can be related to high, medium and low-risk appetite.
How can you measure risk in a portfolio?
There are many ways to measure risk. It involves complicated mathematical calculations. Seek expert knowledge and input for this purpose.
One of the well-known methods is to determine volatility. It can be measured by calculating the standard deviation. Include the correlation or the covariance of assets and calculate the total return by considering the weighted returns and averaging them. It applies to equities separately and portfolios as well.
How to manage investment portfolio risk?
Managing risk is a fundamental financial responsibility. You manage risk by
- Diversifying portfolio and purchasing different types of assets such as mutual funds, real estate, life insurance etc.
- Keep monitoring market sentiments and take precautions.
- Take expert advice if required.
- Invest in equities only when you are planning to invest long term.
- Choose to invest in insurance cum investment options like ULIP policy.
ULIP plan requires special mention here because it is identified as one of the best financial instruments for dual benefits; insurance and investments. There are ways to manage risk by availing of ULIP insurance. Let us understand this product in a little more detail.
ULIP Insurance
Unit Linked Insurance Plan’s one portion of the premium paid is used as life coverage for the sum assured, and the other portion is invested. The amount is invested in equity, debt or hybrid funds. Based on the risk tolerance level, you can choose as per your requirements.
The insurance cover is beneficial for your family members when you meet with your unexpected death. The sum assured can be enhanced with various riders like accidental death rider#, critical illness and terminal illness rider, total and permanent disability rider and waiver of premiums rider. It will help you manage any risk affecting your investments by providing the insured amount at the right time for catering to recurring expenses.
ULIP returns are market-linked. The insurance company will analyse and provide a list of funds. You can choose equity funds for risk and hybrid funds for balanced risk. TATA AIA Life Insurance insurance provides a good number of investment funds to manage risk in our portfolio. The ULIP plan also helps you to switch between different funds during the policy tenure. There is a lock-in period of five years. The premiums paid will be used for insurance cover and further for the investments. Hence, it is an ideal option for long term investments. After five years, partial withdrawal is allowed. As per the Income Tax Act, 1961, the premiums paid towards the ULIP plan qualifies for tax* deductions under Section 80C, and the ULIP returns are exempted under Section 10(10D) with certain terms and conditions.
How can ULIP policy mitigate risk?
- ULIP plans can provide a secure investment by including insurance for protecting the family's financial obligations.
- The insurance companies provide a range of funds for investment in ULIP where a customer can manage their asset allocation based on their risk appetite
- By switching between different funds, you can manage risk as and when the situation demands.
Conclusion
Having seen what investment portfolio risk is and the different types, it is very important that we take appropriate steps to avoid making irrational decisions. Analyse your income, expenses and the extent of fund you can allocate for investment. Make a diversified portfolio with a good balance of risk to sustain a long-term investment. Options like ULIP policy can safeguard your investment and your family's financial position. Take investment decisions early in life, incorporate risk managing strategies and secure your financial future!
L&C/Advt/2023/Mar/0913