I usually meet investors who’re enamored to generate high returns. They’ve a particular return in mind even before embarking on the investment journey. It includes goals like doubling the money in five years or achieving 20 per cent returns every year, etc. This obsession on returns could lead them to pile on risk, which they’re not capable of handling. Though, it’s good to have a target goal in mind but we can’t derive a plan working backwards from the return angle. That could lead to risk ill-fit.

So, when the investment thesis is built on backward engineering of returns, we could possibly arrive at a portfoliobut would it suit the investor is moot. What many fail to realise is the importance of luck factor in such situations. For instance, during the crypto currency boom of ’21, many investors chasing for higher returns indulged in newer crypto coins or altcoins. Expecting 10x and even high returns may got burned while some got lucky.

This is not restricted to retail investors, the pursuit of unsustainable returns could lead to downfall of even celebrated investment managers. Take the case of Bill Hwang’s family office, Archegos Capital. When the concentrated bets backfired, the lack of appropriate risk management resulted in the meltdown of the firm, wiping out about $20bn overnight.

Instead of indulging in mindless risk, investors are better off by understanding themselves first. They could begin with assessing their risk tolerance. It’s not just about the answering some hypothesised questions but create a scenario analysis to understand how a huge market correction could impact their finances. It’s not only the level of correction but a prolonged underperformance of the portfolio would impact them.

Another aspect of the risk tolerance is the psychological and behavioral effect it would have on the investor. Investors could dwell their own past and check how they reacted to a similar situation. What was their reaction to such an outcome? A behavioral risk profiling is necessary so that their decisions would be more in sync with their tolerance range.

While concentration could benefit, it’s ideal to diversify, particularly for those with limited resources and moderate risk-taking abilities. A single asset concentration could benefit if the cycle plays out well in our favor and have a deeper understanding on that investment. Also, if it matches your goal timelines, then it could benefit. In all other cases, it’s better to diversify the risk that could provide better risk-adjusted returns.

Focus on those we could control i.e., the risk management. Remember that returns are always an outcome of risk management. Market returns are unpredictable and not in our control. But how we respond to the market reactions is in our control. With proper diversification and better understanding on our investments, we could remain stoic in chaotic times. Approaching investment with realism is healthy. If your risk appetite is lower but if the goals are higher, then either one needs to increase the savings or increase the timelines. Unrealistic expectations leave bitter investment experiences resulting to building wrong biases into the system. It would further worsen the investment decision making process.

Chasing investment returns without considering risk is like driving a car at top speeds without brakes. It works until it doesn’t. Successful investing isn’t about arbitrary return targets but about balancing risk and reward in a way that aligns with your financial and emotional capacity. By considering risk as priority, investors can build more resilient portfolios and avoid catastrophic mistakes.

(The author is a partner with “Wealocity Analytics”, a SEBI registered Research Analyst firm and could be reached at [email protected])