Risk and return: relationship

This article first appeared on the utvi.com web site – written by the famous anchor, Mr. Vikram Oza. It kind of explains the relationship between risk and return.

The stock markets are risky business. At least that’s the line most people who didn’t park their money in Dalal Street have maintained. But on the flip side, the argument is ‘no pain, no gain’… ‘no risk, no returns’. It’s an age-old dilemma… Damned if you do and damned if you don’t.

Take the case of Nirav Kaku. He’s an IT professional. He, like millions, invested in the stock market consistently during the bull-run. Over the last two years, he parked Rs 24 lacs in it. Today his portfolio has lost half its value. And he’s cursing his luck.

Nirav took higher risks in the hope of higher returns. Was he wrong?

‘Quite’, says Financial Trainer P V Subramanyam. “You may expect higher risks for higher returns, but that’s not always true. To get better returns, sometimes you need to reduce risk – not increase it.”

How do you do that? Here’s an easy approach:

Keep the money you require in the short term (i.e. less than 3 years) in debt instruments.

And invest the money you require in the long term (i.e. like 7 years or more) in equity.

But resisting a ride on the crest of the stock market is tough. Especially when it soars. Blocking out exclamations of joy from those who see the value of their portfolios rise with the Sensex isn’t easy. The trouble only begins when markets do a U-turn and a tailspin all at once. Investors break into a frenzy, and ultimately, despair.

“If you have a long term view, why do you track the markets on an hourly basis?” asks Subramanyam. True. An exercise in futility for all you do is die a million deaths – without hope of nirvana.

Then again, from another perspective, the markets going down are good for young investors. After all you have the opportunity to invest for the long term, getting stocks that you wouldn’t get – at unimaginable prices.

Indeed, with a long term vision, investing in a bearish market isn’t a risk, it’s an opportunity.  Trading is risky, but not investing. As Warren Buffet says, “If you know what you are doing, there is no risk”.

Think about it this way. Not taking a risk is also a risk. For one, the money that you keep under your pillow would erode all its value with rising inflation.

The idea then is to manage risk. Here’s how:

Study your portfolio from time to time, say every six months. And then identify your risks. Your risks will typically change over a period of time with changes in interest rates and inflation. Your default risk also changes when the company you’ve invested money in, goes bankrupt.

Set your goals… the crucial ones like retirement and the not-so-crucial ones like that Tag Heur watch you wanted to indulge in. That way, you’ll see how you can best reduce your risk.

Keep a balanced portfolio. Spread your risks across different asset classes. You should have money in a savings bank account, PPF, Fixed Deposits, Gold, Real Estate and Equity. Ensure you’ve allocated 50-60% in equity with a long term vision and the rest in other asset classes.

Remember! You can’t avoid risk. At best, it can be managed

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