The last couple of years have not been kind to investors at all. Equities (the broader indices) have near-crashed, debt mutual funds have also sprung unpleasant surprises, real estate has languished. And if things couldn’t get any worse, the so-assumed last bastion of safety for investors – banks, has also been breached.
In the last few weeks, two specific pieces of bad news has hurt investors and further spooked markets which already were like a cat on a hot tin roof. The first relates to the NPA woes of Yes Bank, and despite the repeated assurances of the management, investors are panicking and not only are its shares being dumped by investors and employees, there are anecdotal stories of FDs and even basic accounts being moved.
The second piece of news is far more chilling to the retail investor. The RBI suddenly froze all accounts and transactions of PMC (Punjab & Maharashtra Cooperative) Bank, a medium-sized cooperative bank, throwing its depositors and customers into serious emotional turmoil and financial crisis. It turns out that nearly 3/4ths of its loans are NPA (non-performing asset, which in simple words means – unlikely to be paid back, at least in whole), having been advanced to a single customer (in brazen violations of existing regulations), which has gone bankrupt. What is sad is that there seems to be not much hope immediately in store for the thousands of retail investors who had deposited their hard-earned savings in the bank, and whose monies and access to liquidity has got stuck all of a sudden.
This leads me to the titular question – “As an investor, which asset class is safe enough to invest?” While I am sure this question is on many investor’s minds, this question is better answered by flipping it and instead asking oneself – “As an investor, how much do I understand the risks?”
Let me explain further. Most of the time, investors burn their fingers because they invest without fully understanding the products and the risks that they carry. Usually the only understanding of risk that they tend to have is volatility, which they then convert into a perception of capital protection. Ie. Equity is very volatile, and capital loss can be significant. Debt is not at all volatile and is like an FD, therefore capital protection is guaranteed.
Unfortunately, this is an incomplete picture of the risks that the products carry. At a recent seminar I attended, a speaker used the iceberg metaphor to depict the unseen factors behind results (success or failure) and it is apt here as well. Risk is also like an iceberg. While some part of it is seen, many parts of it remain unseen. And importantly, as an investor, while it may not be possible to identify all the risks (ie. many parts of it will remain unknown), it is necessary to understand and estimate it, to be able to manage it.
Eg, In the case of Equity, volatility is seen as the primary risk, but actually that’s not the risk investors should worry about, since over the medium to long term, the volatility subsides substantially. That said, business risk (how will the company perform) and concentration risk (% share of the company in the overall portfolio) are important risk factors that need to be managed.
In the case of debt, investors have some understanding about interest rate risk, since they know that FDs when renewed may be at a lower or higher rate, depending on the prevailing interest rate. On the other hand, the general investor belief about debt is that capital protection is guaranteed, and hence one sees a bee-line for some of these corporate deposits or debentures, which offer much higher rates vs the prevailing rate in the market. Key risks that investors ignore in the case of debt are credit risk (what if the company fails to pay either the interest, or worse, the principal as well) and business risk (what if the company you are putting your money in has bad lending practices and hence sinks eg. PMC Bank).
So, leading back to the question we asked originally, unfortunately, the answers aren’t black-or-white. Investors would be prudent not to chase so-called “safer” asset-classes basis their past experiences. They should instead spend time understanding the risks involved and managing them. Your investment is safe only if you have taken the necessary and right steps to manage the risks involved in those investments. Managing the risks involve having the right asset allocation basis your (the investor’s) investment time-horizons as well as appetite for risk, identifying the right investments within each asset class, as well as making sure that there is adequate diversification, both across and within asset-classes.
While the above is not rocket science, having both, the right expertise (analysis and research) and pain-staking effort (regular review and course-correction), is required. And importantly, the need to “unbias” yourself while evaluating your choices and taking your decisions is essential. If you are new or busy, then having access to a trusted advisor will help you manage your portfolio better in terms of both risk management as well as adapting the portfolio to best suit your needs and goals.
To summarize though, remember – understanding the risks is key to determining safety of your investments. Without adequate understanding, even the safest-seeming investment can turn out to be super-risky, while with some level of understanding and risk-management, investors can navigate their way safely through even seemingly high-risk investments.
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