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Balancing Investment Between Risk and Return on Investments

A mindful investment that balances risk and reward helps you manage income and save money for the future. To know about the management of a balanced and diversified portfolio, go with the flow of the blog.

  • Jul 28, 2023

Updated On: 28th July, 2023

Financial management is among the priorities to lead a stable and financially independent life. It helps you properly manage your income and expenses in the long run. Along with this, the right investment strategy builds a corpus of funds for the future.

    Key Takeaways

  • A balanced investment portfolio is one where assets are allocated to mitigate the risk.
  • By adding liquidity to the portfolio, you can rebalance the investment in the event of market fluctuations.
  • The risk-return tradeoff depends broadly on three major factors, including the investor’s risk tolerance, the investor’s years to retirement, and the potential to replace lost funds.
  • Time also plays a crucial role in determining the level of risk and reward.
  • Asset allocation is essential in determining the risk and return of the portfolio.

A Closer Look at Balanced Portfolio

A balanced investment portfolio is one where assets are allocated to mitigate the risk. Generally, the diversified portfolio includes 60% stocks and 40% bonds. Cash or money market components can also be included in the portfolio to add liquidity. Moreover, the management of a portfolio also depends on your age, as younger investors usually have higher risk tolerance along with the time to recover from losses.\

Risk-Return Tradeoff

The risk-return tradeoff depends broadly on three major factors, including the investor’s risk tolerance, the investor’s years to retirement, and the potential to replace lost funds. Along with this, time also plays a crucial role in determining the level of risk and reward. For investors, the risk-return tradeoff is an essential component of every investment. Therefore, you must have a look at the following section to calculate risk and return.

Alpha Ratio

You can use Alpha Ratio, which refers to returns earned on investment above the benchmark return. Therefore, it measures excess returns from the benchmark index. To calculate alpha in an easier manner, subtract the total return from a comparable benchmark in its asset category. For asset investments that are totally similar, calculate alpha using Jensen’s alpha, which uses the capital asset pricing model as a benchmark.

Beta Ratio

The beta calculation measures the expected move in stock relative to the overall market. To calculate beta, you need to divide the variance by the co-variance. A beta greater than 1 shows that the stock is more volatile than the broader market. However, a beta of less than 1 suggested a stock with lower volatility.

Sharpe Ratio

A Sharpe ratio determines whether the risk is worth the reward. To calculate the ratio, you must divide the adjusted return by the level of risk or its standard deviation. While comparing similar portfolios, the greater the Sharpe ratio, the better, as it shows an attractive risk-adjusted return.

Tips for Investment

With proper financial planning and investment, you can lower your future financial burden. Hence, it is essential to have some tips that can help you in your investment journey.

  • Asset allocation is essential in determining the risk and return of the portfolio. Therefore, asset allocation helps in defining a well-diversified portfolio for mitigating long-term losses.
  • Before putting funds into the portfolio, you should evaluate the risk tolerance and examine your willingness to take risks, as not every asset does not fit every investor.
  • Research is the foundation of every investment. It aids in the decision-making process with relevant information. By performing research, you can learn about a company’s health before actually investing in it.
  • To add liquidity to the portfolio, you must include some cash. In the situation of market fluctuation, liquidity aids in rebalancing the portfolio. This will help you achieve higher returns.

An Option You Can Consider

If you add only equity and banking stocks, you take a huge bet on interest going down. One better way to manage risk is through SIP. Under SIP, you do not commit your fund in one single go and keep your options open. In addition, SIP is phased and hence, provides you with the benefit of rupee cost averaging. Thus, it reduces the overall cost in a volatile market.

Saving plans are also an integral part of financial planning as it provides systematic and disciplined investment for short-term as well as long-term financial goals. It is a life insurance plan focused on accumulating wealth for the future. Investment in saving plans also helps in navigating medical emergencies, post-retirement expenses, or any rainy days.

Wrapping Up

It Is not always the case where higher risk entails higher return. Therefore, you must choose the risky investment depending on your risk potential. Hence, it is always advised to diversify your portfolio to reduce risk by combining assets. Moreover, there are no investments that guarantee return; hence you must tradeoff risk and return.

In this policy, the investment risk in the investment portfolio is borne by the policyholder.

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