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No returns without risk

By Amit Trivedi
January 29, 2007 10:56 IST
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There is a similarity between investment products and tobacco: no deal is possible without a statutory warning of risks involved.

However, the semblance ends right there as most people get scared of the risks in the prospectus of an investment product, while they tend to ignore the warning on the packet of the tobacco product!

Interestingly, though, possibility of a better life in future is strong in the case of investment and there is absolutely no such possibility as far as tobacco products are concerned. The risk-return relation in the context of investments is amazingly similar to those in other aspects of life.

But the perspectives of people are so different that it defies all logic. One can draw many parallels, but there are two that I specifically like the most.

The first one goes something like this: In an investment seminar, while elaborating on investment in equity, the speaker asked the audience how many had ever ventured into the equity markets. Very few hands were raised.

The next question was addressed to those who did not raise their hands, "Why? Why have you not invested in stocks so far?" Well, they were afraid of the risks associated with stocks and few thought there could be any profit at all. They also believed that longer the term, higher the risk involved in stocks.

The speaker then changed the course of discussion asking an unrelated question. He asked how many of them rode a two-wheeler. Almost all did. When asked how many wore a helmet, the answer was none. This struck a cord. There was utter silence in the room. A very effective way to prepare the ground for a presentation on equity investing!

However, think about it. It is not all about irrationality of the investing public that they valued their money more than their life. It was all about the knowledge they have regarding riding a two-wheeler versus investing in stock markets.

Most of them knew how to drive a vehicle in the city traffic - they knew about the rules of driving, the conditions of the road, the vehicles they used. They knew how to manoeuver the vehicle out of a difficult situation.

They could also anticipate with a degree of certainty how another driver would behave. It is this knowledge that makes the risk of accident look low.

If that is the case, would it not make sense to explain to the investors the risks of the market and present them with possible risk management tools? Won't the approach to investing change in such a case?

The following second analogy helps explain the relationship as well as the investment strategy: Most people, while talking about the risk-reward relationship, mention the phrase "high risk-high return", which indicates that one can expect to get high returns if one takes high risks.

However, the order needs to be changed from "high risk- high return" to "high return-high risk". Let us look at another analogy to understand this point better.

Everybody wants to go to heaven (reward), but nobody wants to die (risk). But in order to go to heaven, one must die. However, death does not ensure an entry into heaven.

And that is the simple relationship between risk and return. The very presence of risk brings in an uncertainty on returns. Taking this analogy further to what the religious or philosophical teachings tell us, we may ask: what, if not death alone, can get us an entry into heaven?

Restrain from exotic products and stick to simple and time-tested investment products and strategies. Often, we crave for the new since we get bored with the old and routine. But it is important to remember that the staple diet is never the most exotic - generally the exotic food is eaten only occasionally and not daily.

It is not for nothing that the most exotic stuff is also called "junk food". Treat almost all exotic investment options also as "junk investments". It might not be a coincident that the most exotic investment of the early 80's in the US was the "junk bonds".

Balance - as in life, so in investments. We have heard a lot about the work-life balance, balanced diet, balanced thinking, balanced food, and so on and so forth. In case of food, even when you have seasonal fruits and vegetables, the diet is never made entirely of the seasonal items - the diet is always preferred to be a balanced one. The portfolio of an
investor also needs to be balanced.

What is the ideal balance? Like in food, there is no "one-size-fits-all" menu in investments as well. The portfolio needs to be balanced depending on the situation of the investor - not based on what the season (the levels of the stock prices, the current trend of price movements, or even the outlook on the future of the prices) is.

"Diversification" and "asset allocation" are two terms most investment advisors use very often and at times, without proper understanding. Diversification may lead to one not getting the full benefit of the upside in the market price of one security, or one group of securities, or an asset class, or a market. Is that a point to bother about? What is the objective, after all? It is all about securing one's financial life and not "bhala uski kameez meri kameez se safed kaise?"

Doing our job in spite of the obstacles or temporary setbacks - John Bogle, the founder of Vanguard, uses a phrase, "Press on, regardless" or as the Bhagvad Gita says, "karmanyevadhikaraste, maa phaleshu kadachana; maa karma phalheturbhuhu, maa te sangotsu akarmani" (translated in English it means: you have the control over your work, but not the results. Do not work only with the end result in mind - as the end may not justify the means in certain cases, and never stop working.)

It is often in the darkest of the moments, the seeds of better times are sown. It is the lowest of the market price levels that most investors give up investing or take the money out of the market - and the prices start moving up just then. Mutual funds have talked about a great concept of regular investing - the systematic investment planning.

Keep investing as long as you have surplus available and the results would be very much there for all to see. One is not suggesting here that the equity market will only go upwards always - there is no guarantee of that. However, a careful investment planning has the potential to reduce the possibility of mishaps at least.

The writer works with a leading mutual fund and the views expressed are his personal views
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