Have you managed your risk

Managed Risk

Whether it is investing, driving or walking down the street everyone exposes themselves to risk. At the outset, let us first understand what is risk in investing? We often hear people saying that you should not invest in XYZ, it is risky. To most of us, risk in investment is when market value goes down below the amount so invested. For instance, if Rs.1 Lac invested becomes Rs.98000, we presume it to be a risky investment.

Types of Risks

Well, the definition of risk is broader than what the common man thinks it to be. Primarily there are two types of investing risks:-

  1. Risk of Capital Value going down
  2. Risk of Purchasing Power going down

The first risk is well known but the second risk is not known to many. Mind you, the second risk can be much more hazardous than the first one. The second risk is the inflation risk which is a hidden threat to investments and while one may be under a false sense of security that his/her investments are making returns; there’s a possibility that in real terms he/she may be losing money. That’s because the cost of living is rising which implies that Rs.1000 will buy you less in 10 years’ time than what it does today. So for investments to be safe one needs to make sure that they are earning more than the rate of inflation.

Understanding Risks

It’s impossible to avoid risk when you invest. But the important thing is to understand the risks and then keep them within a level you are comfortable with. And hence while investing an investor has to take into account both – the capital protection and the purchasing power protection.

Short Term Investing

If you are investing for your short term goals – capital erosion is a bigger risk and hence capital protection should be the main concern while investing. Interest bearing investments are best suited for such needs as they offer stable returns and can be liquidated easily.

Long Term Investing

If you are investing for your long term goals for let’s say more than 10 years, purchasing power protection should be the main concern. As with time, inflation may erode the purchasing power of money and one may fall short of the requisite funds when the goal arrives. Equities are the best investments for such needs.

The moment we hear equity, what comes to our mind is – “equities are risky investments”. Yes, equities are volatile and very risky investments but only if one invests in it for short to medium term. But equities are the best bet for the long term planning as they protect the purchasing power of money thereby beating inflation.

For instance if one wants to plan for his/her kids higher education which is 10 years from hence; he/she should consider investing in equities as they beat inflation in long term. But we often do the converse of it; we invest in interest bearing products such as FD’s, NSC’s, PPF, traditional insurance policies (endowment, money back, child plans etc.). What we seek here is the capital protection and ignore the purchasing power protection which is more relevant for our long term goals.

With even the best of advice that one seeks, investing is never going to be risk free. The combination of high returns and low risk does not exist in the real world. All we can do is, with careful planning we can identify and manage the risks that might be a hindrance to effective accomplishment of our goals.

Author:

SLA Financial Solutions is a Leading Advisory firm based out of Jaipur. We are amongst the top 5 Financial Advisory firm with a team of 20 + people. We have been awarded twice by CNBC as best Financial Advisor across North India.