“A ship is always safe at the shore – but that is NOT what it is built for.” who said this?? And is he talking about ship or something else?? Albert Einstein said this 75 years back but I am sure this can be applied to our life, career & definitely investments.
We invest so that our money earns more money – I think NO. We invest so that we can achieve our goals – now you decide the investments which can help you in achieving your goals. But of course there is some trade-off between risk and investment returns – mostly higher risks are associated with higher returns or vice versa. (But… – what is Risk?) It is important to understand risk and risk management associated with investments.
Risk & Your Investments
Risk is an integral part of investment
If you have to get a job, you have to attend an interview. There is a risk that you might not do well in the interview or there are candidates better suited to the role. So there is an element of risk involved. Similarly, it is difficult to find out an investment option that gives returns with zero risk. When you buy real estate, there is the risk of prices going down or prices remaining same or you may not be able to sell it when you will require money. When you do investment, risk will be there. It is important to understand the risks involved in different types of investment and decide the most appropriate ones depending on how much risk you can financially take and how tolerant you are to risk. Fixed deposits have lower risk involved in losing capital or interest rates fluctuation but give lower returns compared to shares of blue chip companies in which there is a higher element of risk. Someone rightly said “Doubt kills more dreams than failure ever will.”
Risk and Volatility are different concepts
Volatility means the value or price of an asset rises and falls sharply in regular intervals. Risk is the potential of loss in investment. High volatility does not mean high risk and at the same time, low volatility does not mean low risk. In short-term volatility in prices can affect you as if you want to sell and get money in the short-term. But if you will focus on the Goals – you will be able to digest volatility to some extent.
Inflation is a risk to investments
Inflation means rising prices. It erodes purchasing power. Savings in your bank account earns 4% per annum. But if inflation is 6% per annum, your savings will lose value every year. The value of Rs. 50000 today will be lower one year down the line and even lower 2 years from today. Investments made for retirement have to be reviewed regularly. If inflation is high, the amount that would be available for you at retirement will not be sufficient to sustain your lifestyle and achieve goals. You should understand debt will always generate negative returns – after adjusting for tax & inflation. If we assume this return is negative 3% – actual value (purchasing power) of Rs 100 invested today will only be Rs 75 after 10 years. THINK
There are many unknown factors that can impact investments
There are a lot of views and analysis on the macro economic conditions, micro economic factors, economic growth and various investment options. These views and analysis help in estimation of performance of asset classes. But even if one correctly analyses all these factors and takes decisions, one can never be sure as there are a host unknown factors that can affect investments. Global financial conditions, conflicts between countries, epidemics, volatility in prices of commodities like petrol can cause fluctuations in value of investments. There can be a swarm of investors acting in a certain way that causes the markets to behave differently than predicted. It is difficult to predict such conditions and factor into technical analysis. Therefore risk is always omnipresent in investments. Carl Richards summed up in one line “Risk is what’s left over when you think you’ve thought of everything.”
Risk can be managed by investing in different asset classes
One way to manage risks in investments is to have an investment portfolio of different asset classes. Depending on investment goals, age, risk capacity, risk tolerance and market conditions, one should invest in different investment like debt, equities, real estate, gold etc…. Each has its own risk element and returns percentage. A balanced portfolio that is reviewed regularly will allow your investments to grow and you can manage risk. Do remember that you cannot eliminate risk but only work around it.