All of us want to grow our money so that we reach our financial goals successfully, What if we have to sacrifice some of our current needs to secure a better life later.
Hence for achieving our financial goals, we need to invest our money. But whenever we hear this four-letter word called "risk", most of us get jittery. In that state of mind we base our investment without understanding the risks associated with it or how these will affect our investments adversely.
No doubt risk is a complex phenomenon to evaluate so much so that it cannot be defined in words but yes can be summarized as - assessment of loss. However the risk varies from person to person hence it cannot be common across all sections of people.
As a layman we think that if there is any risk associated with one particular investment instrument implies that it is going to default in future hence we may not get expected returns. It is noticed that aggressive investors accept higher risk in the want of high returns. But if one is a conservative investor, he will lose on high returns instruments as he does not understand the risk associated with the instrument, whereas aggressive investor invests by accepting even the high risk of the instrument though it may not work in his favour all the time.
Investments should always be done in a balanced way and only after understanding and evaluating the risk taking capacity of the investor and the risk associated with the instrument.
So does it mean that high risk always yields high returns?
Unfortunately the answer is "No", you may get high return or less return than the fixed interest paying instruments (If your investments have market linked risk). If any particular investment's performance is market linked, then it may be impacted by macro factors like the country's economic performance besides micro factor like sector's performance, thus it depends on any of these risks. If the performance of market-linked investments is dependent on the country's economic performance, how can you know whether economy is going to perform? Considering that India is a developing country, that is why we have better opportunities as compared to any developed country. That is why it should be left best to professionals who can decide on your behalf that which sectors are going to perform in that particular state of economy by taking your risk appetite into account. Not only this it should be left to them to keep track of your investments.
Let us discuss the various instruments and embedded risks:
Mutual Fund (MF) is one of the preferred ways of making investments for your indirect entry into equity markets. It has its own way of factoring in risks, which means price of the equity shares in MF changes as per the market movements and we take price movement in equity share as the risk. As we all know Equity shareholders are the owner of the company hence market value of equity capital shows the company's current market value. When company performance is good or is expected to be good, then the price of equity rises. But it should be left on the fund manager to decide which equity to choose and plan investments accordingly. For such investors - Mutual funds are best bet. Mutual funds come with high liquidity and the daily ups and down in NAV may give us low or high returns but chances of getting good returns in long term are higher.
Risk is not only associated with investment instruments, but also with loans and that is why interest rates of loans differ as per the loan category - secured and unsecured.
In case of Car loans it is always high loan to value ratio because most of the time after few years the depreciated value of car is always less than the outstanding loans. Therefore lender charges you higher interest rate because of risk of low depreciated value than outstanding loan and in case of personal loan, it being an unsecured loan, you will always find this loan even costlier. At the same time in case of housing loans interest rates are low as compared to Car loans or personal loan because value to loan ratio is high (assuming property value will rise).
So you must be thinking that what is the relation between loan and investments?
Both are two sides of the same coin - in one you are lender (investments) and in other you are taker (loan) - the only common factor is risk. It is for this reason that banks, financial institutions, before giving loans, always assess the risk profile of the customer. Similarly we as Investors should evaluate the risk associated with any investment instrument after judging our own risk taking capacity.
Sachin Bobade, Research Analyst, Apnapaisa.com
ApnaPaisa is India's leading Online market place for financial products such as loans, credit cards and insurance plans. Author can be reached at www.facebook.com/apnapaisa.