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How To Construct A High-Risk Portfolio

 Courtesy : Investopedia

A lot of investment advice centers on producing as much return as possible for as little risk as possible. But what about the other side of the coin? What about embracing the possibilities of risk and actively seeking to build a high-risk investment portfolio? Such a portfolio could hold considerable promise for market-beating returns, but investors need to keep a few ideas in mind when approaching this type of investment portfolio.



Why Seek Risk?

The linkage between risk and reward is not always perfect or predictable, but there is a time-tested correlation between risk and reward. If investors want higher returns, they have to be willing to take on higher risk. Said differently, though, if an investor can accept higher risk, he or she can also potentially realize considerably higher returns.
A low-risk/high-return portfolio is more often about fantasy (or fraud) than reality. Moreover, not all risk is bad for an individual investor. The key, then, is taking on the right risks. After all, risk only becomes problematic if, or when, an investor is wrong. There are also different ideas of risk; holding an all-cash portfolio is actually quite risky if that cash is being eroded by inflation. 

Large institutions cannot afford the risks that go with low liquidity, but that threshold is much lower for an individual. Even a small fund may be unable to invest in a $20 stock that trades 50,000 shares a day, but there is no reason that an individual investor cannot take on that liquidity risk. Likewise, many institutional investors cannot invest in low-priced stocks, pink sheet/bulletin board stocks or stocks in certain industries (particularly for certain ethical funds), but individuals have no such statutory restrictions.

It is also important to understand another key detail of "high-risk" portfolios – volatility is NOT risk. True, many academics and market participants do use volatility as a proxy for risk (beta, for instance), but in many respects volatility is a poor analog to risk. Risk, as most investors would define it, is either the probability of loss or the probability of an asset (or collection of assets) providing less than the expected return. 
Some stocks can go through wild up and down swings, but still produce handsome rewards for investors. In other cases some stocks just quietly and steadily fade into oblivion. In many respects, then, volatility is like the turbulence experienced on a plane ride, whereas risk is the actual chance of crashing.

Seek Out Smart Risk / Not All Risk Is the Same

One of the most important concepts in building a high-risk portfolio is that not all risk is the same. A close corollary is that investors should only seek out the smart risks, the risks they get compensated for taking. For instance, investing in the equity of bankrupt companies almost never pays off; yes the stocks trade for pennies and the companies often survive, but the bankruptcy process almost always completely wipes out equity investors and there is not enough wiggle room in that "almost" to validate the risk.
Investors should also guard against laziness and complacency. High-risk investing demands responsiveness and attention to detail. So while building a portfolio without thorough due diligence and then ignoring it is certainly high-risk investing, it is not a kind of risk that will earn extra rewards.

Types of High-Risk Portfolios

Concentrated

It is possible to create a high-risk portfolio without really changing investment styles. Heavily investing in a single sector/industry can certainly amp up risk and increase return potential. Investors who over weighted into technology stocks during the late 1990s (and got out in time) did quite well, as well as investors who successfully play cyclical commodity runs.
Perhaps it goes without saying, but this strategy is predicated on really understanding an industry well and having a good sense of the industry's place in the business cycle. Likewise, it is important to have a good sense of market psychology and moods; over weighting an unpopular sector is not likely to boost returns.  

Momentum investing - is another option for a high-risk portfolio. The basic idea of momentum investing is to invest in stocks already showing strong price action. The risk from this strategy is often due to the above-average valuations that popular stocks carry, but expensive popular stocks can often trade up to "very expensive" or "extremely expensive" before fading.
Momentum investing requires strong sell discipline (using tight stop-losses when momentum fades, for instance). Investors can also look to diversify across sectors to lower absolute risk, but a general market decline will hit a momentum portfolio hard unless an investor is nimble enough to go short. 

Penny Stocks

Most financial information sites go to great lengths to dissuade investors from investing in penny stocks, highlighting the prevalence of fraud, corruption, and hype as well as the overall illiquidity of these stocks.
While those are valid issues, some times the enormous risks of this investment type do pay off. Penny stock investing requires exceptional commitment to due diligence, and diversification can help reduce the risks.

Emerging Ideas

Risk-seeking investors can also take a page from venture capital and look to invest in emerging technology companies. At their best, these companies can give investors something close to a "ground floor" opportunity in new technologies and products. Once again diversification matters, as investors have to be patient and willing to accept a low "batting average", as most emerging technology companies fail. Investors should also focus on companies that have capital and/or access to capital on good terms as many of these companies are pre-revenue and torrid cash-burners.


Bottom LineInvestors with the financial capacity to take on risk should not shy away from it. Over time, intelligent and disciplined risk-seeking behavior can produce substantially above-average returns. The key, though, is "intelligent" and "disciplined"; investors must seek out the risks that can earn them better returns and strictly avoid (or minimize) those risks that do not add any money to their pocket.

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How to book stock market losses and make money

Courtesy : Rediff.com

Booking losses at the right time forms the most important part of wealth management strategy.

Do you book profit or book loss?

You have bought the shares of ABC Ltd at a rate of Rs.100 per share. The current market price is Rs.150 per share. Also you have bought the shares of XYZ Ltd at a rate of Rs.200 and the current market price is Rs 125.

Do you book profits by selling ABC or book losses by selling XYZ.

Rule No.1: Never lose money. Rule No.2: Never forget rule No.1: Warren Buffett

This quote from Warren Buffet is the essenceof selling loss-making investments as part of wealth management. However, to the contrary, most of us tend to sell those investments that make us money and prefer to hold on to those that are already making losses.It is just probably a feeling that we could not have gone wrong and the investment would revive, or on the other hand a feeling that we have been fooled and do not want to be fooled again and do not want to take action.

What to do with loss making investments?

" It's not whether you're right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong" - George Soros

I recollected this saying when an investor told me that he always invested in right investments at the right time. I acknowledged his prudent nature, but felt that he and many other financially prudent persons needed to know that they also required to regularly review their investments to eliminate non-productive ones for productive and paying ones.
Wealth management is all about making money work best for you.
George Soros's lessons of prudent wealth management lie in not allowing your investment to depreciate (fall in value).This involves being ready toleave your comfort zone and revise your investment decision with the right attitude of being proud of the right investment and at the same time not being disgraced or regretful in making revisions or corrections in decisions already made.

Review your investments with the current outlook

Most of us make investments that are based on the information available to us at a given point in time. But it is important to know that with times the profitability or loss of an investment could change. It definitely proves useful to review and revise our decisions when we find that we are holding on to something that no one would buy or invest in now.
It is right that it is human to make mistakes, but holding on to a mistake just for emotional reasons cannot be pardoned. Subsequent events might alter the attractiveness of the investment.
Should we be possessive in our attachment to those investments for which the outlook has changed now? So I would say that if you need to create wealth and manage it, there is nothing wrong in being a fair weather friend; investments have to work for you and not accomplishing this goal means getting out of these investments for better avenues.

Do I need to book losses when the market is falling?

However I wish to be excused when I say it is not good to sell when the prices on the whole have fallen down. However it is again important to believe that poor stocks would surely be losing more than good ones; fall in price just does not indicate a downturn, it is a combination of various factors like production, sales and profits also; so poor stocks or small companies may find it difficult to recoup even when we experience favorable times in the market.
Again during the fall in the market it is common for us to see that even good stocks may be available at a discount. I would say such times are ideal to liquidate poor performing stocks that are not doing well and purchase good stocks.

Why should you book loss?

Booking losses in poor performing investments has got some advantages. So as to quit the poor performing investments, you are forced to quit your ego and admit that you have made a wrong investment decision.
As you admit your mistake, you learn a lesson. As you learn a lesson you do not take similar wrong investment decisions in the future.
The advantage of booking losses is you move out of poor performing investments and moving into better performing investments. So you will be able to recover your losses faster.

How to Get Tax Gains from Your Losses in Shares

Courtesy : NDTV

 For the purpose of tax computation of total income of an individual, all incomes are classified under five heads, under the Income Tax Act: salary, income from house property, income from business or profession, capital gains and income from other sources. The total income under all these five heads of income are added and after allowing deductions the total income tax is calculated based on the tax slabs.

However, tax laws allow setting off of losses against gains in the same category, based on different criteria. If an income is tax-exempt, it however cannot be adjusted against any loss from an income that is taxable. For tax computation, profit or losses in shares are clubbed under the head of capital gains.

If an investor has held shares for less than 12 months from the date of buying, then the resulting loss on its transaction on stock exchanges, if any, is termed as short-term capital loss (STCL).

This loss can be adjusted against the short-term capital gain (STCG) or long-term capital gain (LTCG) from shares, if any, thus lowering the tax outgo. Short-term capital gains from equities are taxed at 15 per cent. (If an investor has held shares for more than 12 months, then the resulting gain/loss is termed long-term capital gain/loss.)

If the short-term loss cannot be set off in the same fiscal, then the balance can be carried forward to subsequent eight years. In each of these, the said short-term losses can be set-off against short-term capital gain (STCG) or long-term capital gain, if any.

To reduce outgo, many investors set off gains made from equities in the fiscal against losses occurred in same year or previous year. They book losses, if any, on existing holdings and then later repurchase the stock to keep their holdings intact.

For example, an investor has already booked short-term profit (by selling within 12 months) of Rs. 10,000 in some stocks. At the same time, the investor is sitting on un-realized loss of Rs. 4,000 in some other stocks.

In that case, the investor has to pay short-term capital gains tax at 15 per cent on Rs. 10,000 profit. To reduce short-term capital gains tax liability, the investor can sell the stock on which he is incurring Rs. 4,000 of losses. In that case, the investor's has to pay tax on Rs. 6,000 (Rs. 10,000 - Rs. 4,000), not Rs. 10,000. To keep his holding intact, the investor can later repurchase the stock.

However, long-term capital losses on shares can only be set off against long-term capital gains, if any. Further, any long-term capital losses that cannot be set off against long-term capital gains arising in the same fiscal can be carried forward to subsequent eight years.

Disclaimer: "Investors are advised to make their own assessment and counter checks before acting on the information. - Tax Rules are subject to changes "