Risk in investments
Many of investors problems will reduce if they understood RISK. Either they notice it very closely or ignore it totally. Lets try to see what risk is.
“Risk is defined as future uncertainty about deviation from original expected outcome.”
Various investments and their associated risks we can look at are:-
- Fixed Deposits: Many of investors think Fixed deposit is a Very safe investment. It is meaningless to mention the bank default risk, because people will hardly believe me when I share how deposits in a bank are also exposed to the bank’s balance sheet being in good health. The real risk a FD runs with is the ‘inflation risk’. This means your fixed deposit will find it very difficult to beat the inflation. Another risk which is associated with FD will be the reinvestment risk. For e.g. you made a FD of one year at 9.5% and the interest rates in the market dropped to 8% after one year; in such case there is risk of lower rates on redeployment.
- Equity: The risks associated with equities are “Market risk” & “holding period risk”. The market risk means that the change is the price due to changes in the market dynamics and the holding period risk results from the market risk which means when you actually need the money, the markets may be down.
- Debt: Like the FD, all other debt instruments carry the “inflation risk”, but in some cases there is market related returns, which means you can get a little higher returns as well. The other risks with some instruments of debt is “liquidity risk” (as they come with lock-in and cannot be liquidated easily in the secondary markets), “default risk” (wherein the bond issuer fails to honor the maturity date) and “interest rate risk” (where the prices of bonds fall when the market interest rises).
- Real Estate: This asset class comes with its own set of risks such as the “liquidity risk” (buying real estate is the easiest but selling is the toughest), “holding period risk” (you might not get the money actually when you require it), “builder execution risk” (where the builder fails to deliver the project on time), “builder default risk” (builder can go bankrupt in between of the execution of the project) and “estate risk” (a lot of family feuds are born because of real estate)
The above risks are the ones which have come to mind but the economy is dynamic and a lot of changes can give emergence to new risks which we haven’t heard of. Once you understand that risks are there everywhere, then the next step involves how to mitigate these risks and one of the best ways known is diversification or asset allocation. These can help reduce risks in a portfolio and smart investors should understand that investments is all about “Risk adjusted returns” and not alone about high returns.
I will be happy to receive any questions or feedback that you may have.
~ Anil Budhraja