Mirror, Mirror, On the wall, Which is the biggest risk of them all?

“If the highest aim of a captain were to preserve his ship, he would keep it in port forever” – Thomas Aquinas

 

With the market indices at all-time highs (the Sensex touched 40000 and the Nifty touched 12000 on 23rd May 2019, post the election results), it will be pertinent to congratulate those retail investors who have benefited from it. They have benefited because they have stayed invested through the bad year that 2018 was, and therefore benefited from this run up in 2019.

 

Such investors are in a minority today. Most investors either have never considered equity due to fear and lack of awareness or keep their investment to the minimum because they do not want to take the “risk”. By staying away from equities, they avoid a “risky” investment and invest their hard-earned money into other “safe” investments – bank fixed deposits, corporate bonds, gold, real estate.

 

But, is this really less risky? What investors fear in equity is the volatility that is associated with it. By investing in less-risky avenues, one is avoiding this volatility. When one looks at risk in this way, defined as “volatility”, then yes, equities are riskier.

 

But, as an investor, the actual risk that you should be worried about is not achieving your financial goals. After all, of what use is the avoidance of volatility risk in the short term, if one is unable to meet one’s financial requirements in the long term?

 

If you are investing a sum of money without a particular goal and time-frame in mind, then you are making 2 mistakes with your money.

 

  • One, you are not setting any expectation from your investment and therefore cannot review its performance over the right periodicity, and take appropriate course corrections.
  • Two, you will unnecessarily track the movement of your investment frequently and get impacted by the volatility, and since you don’t have a goal or a target in mind, you will move to take hasty short-term decisions with that investment, maybe at a loss.

 

To understand this better, let us look at two commonly occurring scenarios

 

  • A invested Rs 500000 in shares on the advice of his good friend at work, who traded frequently and hence was “knowledgeable”. His friend said that markets are doing very well and if he invests now, he can get a good return in a short time. Instead, 4 months after he invested, the market saw a steep correction and A saw his capital come down to Rs 400000. Not wanting to lose further, A sold the shares at a loss, in 6 months.

 

 

  • B bought a second house in an upcoming suburb and took a home loan of Rs 80 lakh for this purpose. He bought this house because the suburb was slated to be close to the new airport and as per everybody he talked to, the area was slated to explode in a few years. Unfortunately, the house took 3 more years than planned to get possession, and the location still hasn’t developed to that extent, and hence isn’t yielding a decent rental. B still has nearly another 10 years to repay of the loan, and the outstanding loan is more than Rs 60 lakhs.

 

Do these sound familiar? So, what went wrong? In both these cases, the investment was neither planned, nor reviewed, with an underlying purpose. And hence, while the vehicles (shares, house in suburbs) themselves may not have been poor investments, wrong actions were taken (sell shares early, hold on to the property too long).

 

The first step in investing is to identify what is the goal one is investing for, and what is the time horizon that one is investing for this financial goal.

 

Once one has identified the goal and the time horizon, then the logical next step is to identify the correct asset class (or mix of asset classes) that one should invest in, in order to achieve the financial goal in the most efficient manner.

 

This should, of course, be done while keeping in mind one’s risk appetite, but years of investing as well as observing investors, leads me to say that risk appetite is not something that is static – this evolves over time, through one’s experiences as well as knowledge.

 

Once one looks at the investing process in this fashion, volatility as a risk is something that gets taken accounted for while taking the investing decisions. And hence is not something that as an investor should worry you, since you have planned for it.

 

In order to achieve one’s financial goals, it is important that your investments not only grow at the right pace, to create adequate wealth to meet your goals, they should also be in the right asset classes so that you have the money when you need it.

 

By investing in so-called “less-risky” avenues, one is putting a sort of ceiling on the returns one can earn, by sacrificing them at the altar of short-term volatility. In addition, one is actually exposed to both liquidity as well as inflation risks.

 

By not taking “risks”, one ends up encountering the biggest risk of them all – not having enough money when one needs it, and in the right form so that one can access it easily without any trouble.

 

So, do yourself a favor and look in the mirror and ask yourself this – do you know what goals your investments are helping build wealth towards? And how many of your investments are actually helping you create wealth that is both, beating inflation and helping you meet your goals?

 

Finwise is a personal finance solutions firm that helps individuals and families plan for their financial goals, follow their passions and achieve financial independence.

 

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For consultations, please reach us at getfinwise@finwise.in or +91 9870702277/9820818007.

 

Image by Gino Crescoli from Pixabay

 

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