There are various aspects of risk management, and it takes a book on risk to cover all aspects. Right now I am looking at some aspects of risk management that we ASSUME, and assume wrongly!
- To be able to manage risk, we should be able to predict EXACTLY what will happen in the future: far from it. No expert on risk is ever able to predict the future. You should be reasonably accurate, that is all. In 1985 when I bought Hero Honda, I knew that the 2 wheeler industry had to do well. After all in a country with so many cycles, the motor cycle had to be a hit. Getting the demographics right, the industry call right, the trend right is some skill. Getting the company right for a long journey is a lot of matter of luck.
- Risk is always visible to experts: WRONG. Experts struggle with risk in a portfolio. Even they do not understand that risk is not some vague number in a risk tolerance sheet. It is REAL, it is the feeling in the stomach, and not really easy for a professional to gauge your risk. At best he can give you a range.
- Risk is Constant: WRONG. Risk keeps changing from time to time and can vary. The birth of a child, marriage, divorce, death of a parent or spouse, job loss, starting a business, taking a loan, spouse quitting the job – and many other factors can all have an impact on the risk profile. Sometimes the market plays a role in the risk taking ability. A bull market makes you bullish about taking risk, and a bear market scares you. Sadly, risk is actually counter intuitive.
- Need to Take Risk is Constant: WRONG. If at an older age, say 75, a person has about Rs. 3 crores in liquid net worth, and has a pension of Rs. 35,000 p.m. And his total monthly expenses are about Rs. 25,000 (own house)..the NEED TO TAKE RISK is completely gone. He can afford to put Rs. 3 crores in 8% Tax Free Bonds and go off to sleep. His expenses may NEVER exceed his indexed pension (hello, 7th pay commission is around). Such a person can shift to a zero equity portfolio without any risk!
- A sophisticated risk calculator is better. Nonsense. The less said the better.
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