You need to
look in the mirror and answer, Are you taking enough risks to meet your goals?
Although it
is often used in different contexts, Risk is the possibility that an outcome
will not be as expected. Specifically in finance, it is always discussed with
reference to returns on your investment. Risk implies future uncertainty
about deviation from expected earnings or expected outcome. Risk measures the
uncertainty that an investor is willing to take to realize a gain from an
investment.
Great things
never come from being in your Comfort zone. In order to grow, we need to take
risks, whether in businesses or in our careers.
Generally we take risks because there’s a gap
between where you are now and where you want to be.
Risk and return go hand in hand
and have a direct correlation, you want to become rich and grow your wealth,
you must take the necessary risks.
Most
investors consider risk only as loss of capital or the reduction in corpus,
whereas to assess risk in the true sense, we need to also consider the risk in
valuation of the corpus or reduction in purchasing power due to inflation and
also the opportunity cost of capital. The benchmark for inflation should not be
the Government sponsored WPI or CPI but also factor in the Lifestyle inflation.
As I’am fond
of saying in most investor interactions, “Ten years ago, who would have thought
that we will buy a Rs 50000 phone on a whim or as a Gift for a loved one every
year.” Hence the need to factor in lifestyle inflation in your investment
strategy.
While
comparing investment options, we have experienced that most investors also
ignore the tax implications and the impact taxes can have on the erosion of the
corpus. Another impact, taxes have, is on the values at which your corpus will
compound every year.
Taxes on
Interest income are on accrual whereas taxes on mutual funds or equity are on
redemption thereby impacting the value of the corpus at the end of each year. E.g.
Lets say you have Rupees one lakh and you buy an FDR @ 6%, your corpus would
grow to Rs 106000 less tax @ 30% i.e. Rs 104200 and next year you would get
interest on Rs 104200. The same amount invested in a Debt Fund @ 6%, would also
grow to Rs 106000, but because tax is only applicable if you redeem, next year
also you would get interest on Rs 106000. The investment over a period of 5
years will lead to a substantial difference due to this factor alone.
Hence, as a
first rule, your investment must generate a return, which beats inflation post
taxes. If you are not able to do that, then you run the risk of losing the
purchasing power of your investment even if your corpus remains intact.
Between the
two major financial asset classes, Equity and Debt, Equity is generally
associated with risk and Debt with safe and steady returns.
The problem
arises when the investor starts taking risks in Debt Investment. The risk in
Debt has been highlighted by the recent FMP crisis and the NBFC defaults,
wherein the investors have lost or are very close to loosing their hard earned
corpus invested in “Safe” Debt.
Risk is for
equity and should deliver the option of higher returns but alas, for a few
extra basis points or an extra percentage return, investors end up investing in
low credit and below par Debt instruments thereby also exposing themselves to
the risk of default.
The portion
you need to invest in Debt as a part of your Asset allocation strategy, should
be in low risk or virtually zero risk options like Government Bonds, FDRs, PPF,
Arbitrage and liquid funds and the like. Please don’t look at an extra return
on your Debt investment and always remember that a higher return can only come
with a higher risk.
The Problem
is not taking too much risk but taking too less risk or taking risk where it is
not required or in the wrong asset class.
Indian
investors have been playing too safe with their investments. Our investments
are dominated by Debt, our portfolios are largely concentrated in FD's, PPF,
RD's, traditional endowment insurance policies (since we get a fixed amount on
maturity), Post Office Schemes, etc.
Warren
Buffett said “Risk comes from not knowing what you are doing”
You need to understand
the vagaries of different asset classes, the risk and return matrix of each
option, to make a wise investment choice and decision.
Numerous
studies and the chart below also clearly illustrates that no asset class can
beat Equity in terms of returns in the long term. Sensex has grown almost 390
times in its 40-year journey from 1979 as compared to 35 times in Gold and 22
times in FD.
A study of
the history of the equity and other asset classes helps us study the probability
of loss while investing in an asset class. One of the major determinants of the
choice of asset class is dependent on the time horizon you have to reach your
goal. To get the best returns from Equity, you need to give it a minimum of
five years and above as is evident from the chart below.
The probability of loss in Equity Mutual
Funds becomes zero in 5 years, whereas in Sensex, it is only 9% after 5 years
and progressively reduces to zero in 12 years.
The 2008
Stock market crash was one of the biggest crashes in the recent history of the stock
markets. The Sensex reached its peak level on 8thJan 2008 when it
touched 20873. Subsequently when the financial crisis unfolded, the markets
dropped by close to 65% to reach the lowest level wherein it hit 7,697.39
intraday and closed the day at 8,509.56 on Oct 27, 2008. After touching a
low of 7,697.39 on Oct 27,2008 Sensex slowly recovered to re-scale 21,000
on Nov 5, 2010 thereby erasing all losses in less than three years.
Lets take
two scenarios; in the first scenario, lets assume that you were unlucky and you
bought the Sensex on 8thJan @ 20873. Subsequently the market started
crashing and you held onto the Sensex for 10 years. On 8th Jan,
2018, it had reached a level of 34353 thereby giving you an absolute return of
65% and a CAGR of 5.11%
In the
second scenario, lets assume that you sold at the lowest point of the market,
on 27thOct 2018at a Sensex level of 8000. If you had bought it Five
years ago the Sensex, on the same day, was @ 4698.28, thereby giving you an
absolute return of 70% and a CAGR of 11.23%.
Hence, even
if you buy at the highest point or sell at the lowest point of the market, if
you have a five-year horizon and more, you will have a lesser probability of
losing money in the equity market.
According
to a study done by investment firm Deutsche Bank, the stock market, on an
average, has a correction every 357 days, or about once a year. While many investors,
especially those new to Equity investing simply aren't used to experiencing
swings like these, but corrections are an inevitable part of stock market.
However,
these corrections offer a major opportunity to buy and gain substantial returns
in the next one to three years.
In a
broader context, while a stock market correction is an inevitable part of stock
ownership, corrections last for a shorter period of time than bull markets.
Based on
research conducted on the Dow between 1945 and 2013, John Prestbo at
MarketWatch determined that the average correction (which worked out to 13.3%)
lasted a mere 71.6 trading days, or about 14 calendar weeks. The Indian Bear
& Bull cycles are also highlighted below and also show a similar trend.
Hence Equity
is also not risky if you have the conviction in the asset class, understand the
market dynamics, have the patience and have a long-term horizon. You may only need
the help of a financial advisor who can help you ride the volatility. He will
also help you make investment decisions based on the current market valuations.
Historically
NIFTY trades at PE of 18 and gives the best return when it trades near or below
the historical levels.
As is
evident from the above data, long term Equity investment can balance the risk
and provide better returns if you have the right time horizon.
If your
horizon is less than five years, you need to shift to Debt or safer asset
classes.
However,
most investors stick with debt despite having a longer time horizon. The
problem with being too conservative is, it leads to sub optimal returns over
the long term, which may hamper the achievement of your financial goals.
The risk
quotient is always subjective; it varies from case to case. The Risk should be
in conjunction with the returns you need.
The Golden
Rule is Young Investors should take more Risk and the older ones should take
less risk. The real risk actually arises when the value of your investment is
less than the value of your goal. Of what use will be a retirement corpus,
created after saving since the last 30 years in 6% FDs, when it will only be
enough to last the next 10 years only, post retirement, when even an additional
4% return created from balancing risk, would have lasted for more than 25
years.
What would
you prefer for your retirement fund after investing Rs 10000 every month for 30
years; Rs 107 lacs or Rs 563 lacs especially when you know the probability of
loss in equity after 10 years is negligible.
The risk you
should take is dependent upon a number of factors, viz.
Your
financial position: income, expenses, assets, liabilities; Family
responsibilities; Your age; The time you have in hand for your goal, your own
risk profile and many such factors.
You must
understand that there are different kinds of risks, some controllable and some
beyond your control.
Ideally, asset allocation has to play an
important role in your investment journey. Consult your wealth manager or
financial advisor to help you choose the most suited asset allocation strategy
for you.A sound Asset allocation strategy will help you optimize the risk,you
need to take to achieve your financial goals.
There are
other asset classes also available, like Real Estate, Gold, Commodities etc.
but the biggest drawback in them is lack of Liquidity, Big-ticket size, leading
to issues of affordability, inadequate diversification and taxation
disadvantages.
Where should
you invest – Finally it boils down to; are you achieving financial goals or
not. The Objective is not to beat the benchmark all the times but to achieve
the financial goals.
The bottom-line
is, if there is a difference between your risk appetite and the risk you require
to take to achieve your financial goals, you need to bridge the gap. Sometimes,
it is ideal to take risk even at a later age to achieve the goals and create
wealth. To have the required money to actualize our dreams, we must take the
necessary risk.
I remember
an old saying, “20 years from now you will be more worried about the things you
didn’t do rather than the ones you did.”
So, are you
taking enough risk?
Consult your
financial advisor today and optimize your risk return balance to achieve your
financial goals.
Happy
Investing!
Stay Blessed
Forever!
Sandeep
Sahni
Note: All information provided
in this blog is for educational purposes only and does not constitute
any professional advice or service. Readers are requested to consult a
financial advisor before investing as investments are subject to Market
Risks.
Sandeep is an alum of IIM Lucknow with a Post Graduate Degree (MBA
class of 1988). His also an alum of Shri Ram College of Commerce, Delhi
University (B.Com. Hons. Class of 1985.)
Sandeep's investing experience and study of the Financial Markets spans over 30 years. He is based in Chandigarh and has been advising more than 500 clients across the globe on Financial Planning and Wealth Management.
He has promoted “Sahayak Gurukul” which is an attempt to share thoughts and knowledge on aspects related to Personal Finance and Wealth Management. Sahayak Gurukul provides financial insights into the markets, economy and Investments. Whether you are new to the personal finance domain or a professional looking to make your money work for you, the Sahayak Gurukul blogs and workshops are curated to demystify investing, simplify complex personal finance topics and help investors make better decisions about their money.
Alongside, Sandeep conducts regular Investor Awareness Programs and workshops for Training of Mutual Fund Distributors, and workshops and seminars on Financial Planning for Corporate groups, Teachers, Doctors and Other professionals.
Through his interactions and workshops, Sandeep works towards breaking the myths and illusions about money and finance.
He also writes a well read blog;
https://sahayakgurukul.blogspot.com
https://www.sahayakassociates.in/resources/our-blog
He has also conducted presentations, workshops and guest lectures at Management institutes for students on Financial Planning and Wealth Creation.
He can be reached at:
+91-9888220088, 9814112988
sandeepsahni@sahayakassociates.com
About The author
Sandeep Sahni
Sandeep's investing experience and study of the Financial Markets spans over 30 years. He is based in Chandigarh and has been advising more than 500 clients across the globe on Financial Planning and Wealth Management.
He has promoted “Sahayak Gurukul” which is an attempt to share thoughts and knowledge on aspects related to Personal Finance and Wealth Management. Sahayak Gurukul provides financial insights into the markets, economy and Investments. Whether you are new to the personal finance domain or a professional looking to make your money work for you, the Sahayak Gurukul blogs and workshops are curated to demystify investing, simplify complex personal finance topics and help investors make better decisions about their money.
Alongside, Sandeep conducts regular Investor Awareness Programs and workshops for Training of Mutual Fund Distributors, and workshops and seminars on Financial Planning for Corporate groups, Teachers, Doctors and Other professionals.
Through his interactions and workshops, Sandeep works towards breaking the myths and illusions about money and finance.
He also writes a well read blog;
https://sahayakgurukul.blogspot.com
https://www.sahayakassociates.in/resources/our-blog
He has also conducted presentations, workshops and guest lectures at Management institutes for students on Financial Planning and Wealth Creation.
He can be reached at:
+91-9888220088, 9814112988
sandeepsahni@sahayakassociates.com
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