Returns tango with risk

Every investment carries an element of risk and an investor must be fully aware of the same

Most of us think that ROI means Return On Investment. This is true; but ROI can also mean Risk on Investment. Risk and return are two sides of the same coin.

When we say ‘high risk, high returns,’ the word ‘returns’ impacts our mind prominently. This is because we all want returns on our investment and rightly so. However, think quietly: should it be ‘high risk, high return’ or ‘high return, high risk’ ?

When we say the former, we feel everyone who takes higher risk will get higher returns. The fact is all high-return investments also have a high risk component. Risk and returns are inseparable.

Is it ever possible for a rose plant to grow without thorns on it? Can a butcher say, I will not see blood and flesh. What about a fisherman who is scared of water? Similarly, there cannot be returns on investment without risk attached to it. The very first risk we take is parting with our money.

There are many kinds of risk attached to different kinds of investments. Before investing, it is important to know about them. A car driver ought to have complete knowledge of the brake and accelerator before starting the vehicle.

The suggestion, however, is not to stay away from investing. One of the biggest risks an individual takes in life is not investing. An equally huge risk is to invest without knowing the associated risks.

Biggest risk

Mitali and Sudhir are a very young, newly-married couple. They wanted to purchase a home. Their landlord was willing to sell the property to them. He was also considerate towards structuring the deal in a manner which would be a win-win for both the sides.

For down payment, they needed ₹25 lakh. Most of the couple’s funds were locked in tax-saving instruments and a plot of land purchased from the money received at the time of marriage. Funds were available but locked in.

This is the biggest risk that faces investors of today.

Investments are made without keeping in mind ‘My GDP’ – My Goals and Dreams Plan. Always keep an eye on ‘My GDP’ before investing.

Types of risk

Apart from the above, the two important categories of risk associated with any kind of investment are (1) transparent and non-transparent risks (2) systematic and unsystematic risks.

When we invest in stock markets or gold, the risk is transparent. We can see the movement of prices and market value of our investments.

When we invest in bank fixed deposits, there is no way to find out how much we are losing to inflation on a daily or weekly basis. Therefore, investments in stock market and gold are transparent risks. On the other hand, investment in fixed deposit, and for that matter, even real estate to some extent, is a non-transparent risk.

Systematic risk is one which exists in the system. Inflation, for example, is a part of the economic system. The moment we invest in any kind of instrument, we inherit inflation risk. Similar is the case with government policies, geo-political tensions and the like.

Unsystematic risk is attached to a particular investment. For example, if the investment is in an equity mutual fund and the government decides to tax investments in gold, our investment in equity will not affected, but that in gold will be.

Similarly, if we have shares of ABC Ltd. and if the MD of XYZ Ltd. resigns there will not be any impact on ABC Ltd. This is because tax on gold and the resignation of MD of XYZ Ltd. are not a part of the system and hence, will not affect all forms of investment.

We must invest to achieve our financial goals but keep an eye on ‘My ROI’ – My Risk On Investment.

(The author is a financial planner and the author of Yogic Wealth)

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