Losing less is as important as making great returns

The process of investing in financial markets is fraught with ups and downs. Regardless of which of the scores of investment options you choose from, you must be ready to take risks for high returns. The element of risk can help you plan your investments wisely and carefully.

Many investors who engage in panic selling do so because they get anxious seeing the value of their investment nosedive. And if they have just blindly chosen their securities to make a quick buck, they do have a reason to panic. But if they have conviction in their choices and are invested for the long-term, they should remind themselves of the fact that losses are a part of investment in financial markets.

As sound as that observation is, it does not mean that you should be okay with losing money. We’re all prone to making mistakes but we would be fine if we admit and correct them. This advice maybe difficult to follow in life but is not as difficult in applying to our mistakes in the financial markets.

Losing less on investments is vital

The volatility or inherent risk in investment options varies. This is true across asset classes as well as within an asset class. For example, stocks are considered riskier than bonds, and among equities, small-cap stocks are considered risker than their large-cap counterparts. When their risk is in our favour, i.e. our investment is gaining, we don’t question it and feel happy with our choice. But when it becomes unfavourable, we become antsy. To reduce our worry, it is important that we choose an investment that knows how to win and lose less when it does.

Let’s take an example: which of the following stocks would you prefer? Stock A gains 45% when markets are rising and falls 40% when they decline sharply. Meanwhile, Stock B rises 38% in an uptick and declines 28% in a falling market. While all of us would enjoy 45% returns more than 38%, Stock B should be the preferred choice because its decline is significantly smaller than that of Stock A. So even though it falls like the rest of the market, it can still preserve capital better than Stock A.

Let’s put numbers into our example. If we would have invested Rs 10,000 each in both stocks, after the rise and fall cycle as per the given percentages, our money in Stock A would have fallen to Rs 8,700, while in Stock B, it would have declined to Rs 9,936. Because of the lesser decline, Stock B was able to preserve more capital.Thus, when markets rise again, your money invested in Stock B will have more chance to grow than that invested in Stock A.

Brace for the fall

As you can see from the above example, protecting your invested money is more important than seeing it grow. Empowered with this knowledge, you can go about choosing securities that can help your portfolio not only brace for a certain fall in financial markets but also limit the decline so that it can reap better benefits when things start looking up again.

You have several investment options to choose from, and mutual funds are a great choice. They automatically diversify your portfolio, thereby preparing it to face a decline better than individual stock holdings. A combination of mutual funds which offer different strategies and invest in different market segments can work even better. So go ahead and limit your losses.