There are risks associated with all forms of investing. The trick is to understand the risks involved in depth.
Let’s say, 1000 shares of Tata Power were bought – it is one’s first investment in the share market. It’s a good company with a long history of profits and a good management team. What can go wrong?
What if the ‘Environmentalists’ protest against coal based power plants? The government will have to react and put in some stringent regulation. The production costs for coal based power generation will go up and profits of Tata Power will get affected.
What if there is an environmental tax on coal because it is a polluting fuel? The cost of power production will go up for Tata Power.
What if the price of coal goes up? What if the areas in which Tata Power operates loses some industries – the power off take from Tata Power will reduce and profits will be hit.
There are many such scenarios.
If any of the above events take place, there is a good chance that the investment in the Tata Power shares may go down by maybe, 20% – 40%.
What can one do to reduce the risk? It is not possible to eliminate risk completely, but there are ways to reduce it substantially.
The word that comes to mind is ‘Diversification’.
There are a number of sectors – Power, Automobile, Banking, Petrochemicals, Pharma, FMCGs, Textiles, Tyres, Mining, Telecom, Infrastructure, etc, etc.
Instead of putting all the money in shares of one company, why not distribute it amongst shares of companies in, say, 5 sectors? The idea being that if the Power sector is hit, maybe the Pharma, or some other sector, will be doing well and make profits, thus offsetting any losses made by the Power company shares that we have.