What is common between the following three terms for an investor?
- Omicron
- Initial Public Offer
- Cryptocurrency
It is a single word – RISK
All the three terms refer to entities which are not fully known to us. The full implications of a move made now, are yet to reveal themselves. This is despite information-based decisions being taken.
We cannot guess the mutant nature of a new virus and the effectiveness of our defence mechanism (vaccines).
It’s tough to gauge how a company will perform in the long run, despite several megabytes of ideas and opinions we consume, before betting a rupee on that.
Cryptocurrency is volatile and has always been so. What we fear now is the volatile political temperament, and their fear of losing control. We are not contesting the validity of fear now, just acknowledging its existence.
HOW INVESTORS RESPOND OR REACT?
Social media platforms are abuzz with ideas and opinions as follows –
“Omicron is a fear being generated to tame wild stock indices, and induce a much-needed correction.”
“Cryptocurrency is a genie out of the bottle. It’s a concept whose time has come, and governments across the world can’t stop the wave.”
“IPOs of loss-making companies are fine, as long as it generates a short-term gain by selling allotted stocks on listing.”
Nobody is in it for the long-term.
But this is only a segment of investors.
Investing apps lure the young into entering the world of investments. It doesn’t matter if they are not fully equipped with financial knowledge. It facilitates encashment of their high risk appetite.
ELEMENTS OF RISK
- Risk appetite
- Risk-bearing capacity
- Risk Management
are all inter-related concepts.
1. RISK APPETITE
Mutual fund advisors and distributors often lament the huge volumes of cash in bank fixed deposits. They stress upon negative inflation-adjusted returns on fixed deposits.
Whatever the argument for or against market-linked products, there is a huge segment of savers and investors which wants safety of their principal amount, and trust banks or government-sponsored small savings schemes.
These are people with a low risk appetite, though the risk-bearing capacity or potential may be high.
Risk perception is about how you view the situation.
Para-gliders in Goa may see the world at their feet, or see an ocean waiting to swallow them.
People also draw conclusions from experience of others in their social circle. It can both dampen or stimulate risk appetite.
The young cannot resist cryptocurrency, because their peer group is doing so.
Those who have suffered economic setbacks during the pandemic are either weary of risking their savings, or want to multiply wealth quickly to offset losses.
2. RISK-BEARING CAPACITY
Risk-bearing capacity is the amount you can afford to lose without suffering severe setbacks.
This needs to be viewed without the lens of peer group pressure, building social esteem or giving in to expectations of others.
It’s not always about buying that expensive home in a prestigious locality to show off. It’s not always about ‘fad investments’.
It is also the inability to say No to being a guarantor to a friend or family member. Thereby, one opens up a new window of risk, leading to a drop in net worth.
But how much can you afford to lose?
It is the amount one can set aside for growth, after providing for marquee financial goals – retirement, higher education, a house of your own, emergency fund and health. Marquee goals can be different for different people.
3. RISK MANAGEMENT
Can you scan through the web without a risk of data breach?
Is it possible to live in total isolation to keep away the dreaded virus?
One has to live with risk, and manage it well.
Risk management refers to diversification and balancing.
1. Diversification
It is spreading your money over different asset classes to offset risk. Consequently, a probable loss in one class is offset by a gain in another.
Total portfolio growth matters more than the growth or decline in individual asset classes or stocks.
2. Balancing
Decide on a certain percentage of your total corpus to be invested in high-risk assets like direct equity, cryptocurrency or gold.
Keep moving money to ensure that this proportion is maintained, and your portfolio is neither heavy on debt or equity or other high-risk asset classes.
3. Insurance
Major risks need to be insured to prevent an unplanned outflow of money in emergencies. Life and healthcare are of prime importance. Insure your house, car and other assets to offset probable damage.
Celebrities go to the extent of insuring their limbs, voice or other vehicles for expression of talent.
I found this video comprehensive and enlightening.
4. RISK OF BORROWING (LOAN MANAGEMENT)
One can borrow money at the click of a button. But the price to be paid is high.
Sellers disguise loans at entry points as “zero-interest’ loans or “Buy now Pay Later” schemes. The interest meter starts if you fail to pay the full amount on the due date. You gradually get into a debt trap, as you underestimated the interest burden. You don’t realise that the actual price of an item that tempted you, can multiply several times over.
Every loan is a risk. It may be a swipe of your credit card or a well-researched home loan for 20-25 years.
What happens if you fail to repay on scheduled dates? Do you have another asset as a backup?
Consult a fee-only financial planner to help you assess your risk potential and suggest suitable measures for risk management.
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