Risk is fascinating. Perhaps the only thing that rivals this fascination is human reaction to risk. This is because it is impossible to predict how people will react to various kinds of uncertainties. For instance, everyone claims not to be scared by calculated risk, but strapped with a parachute on the edge of a cliff, the leap of faith seems insurmountable. Similarly, few people admit that they can be lured by quick money to take great risk. But a lucky streak in a casino turns this belief upside down.
Cliffs and casinos are not the only way to determine your true relationship with risk. Your finances also provide decisive leads. Check the composition of your portfolio— is it a mix of stocks, bonds and insurance? Then you are somewhere in the middle of the risk-reward matrix. You understand the downside of equity and balance your bets by investing in fixed-income instruments as well.
What if a portfolio is composed of only fixed deposits, National Savings Certificates and bonds, much like Mukul Machave's finances? Theoretically, this 34-year-old doctor is at the peak of his risk appetite. Yet, till last December, he had eschewed equities altogether to squirrel away Rs 5 lakh in ultra-safe fixed deposits and National Savings Certificates.
Swot analysis
Strength: Strong conviction in their judgement. Quick in making decisions.
Weakness: Lack foresight. Inability to balance risk and reward. Unrealistic while making assumptions.
Opportunity: Can make a comprehensive financial plan due to high involvement with money.
Threat: Can become resigned to slow growth or heavy losses that result in an inadequate corpus.
"I started investing in equities late because my father had suffered heavy losses in the market. This made me wary," explains Machave. Psychologists believe that ultra-safe investors take cues from other people's bad experiences and shy away from risk. The problem is usually compounded by the lack of knowledge about the risk factors. Machave thinks along similar lines: "I am a conservative investor, but I am aware that with this approach I can't achieve my goals. So I have started learning about equities to overcome my hesitance."
Naresh Pachisia, managing director of SKP Securities, says, "Ultra-conservative investors are motivated by capital preservation. What they do not realise is that high inflation can lower the real returns of debt investments." This is why most conservative investors come up short in their long-term goals despite investing regularly.
If you are guilty of playing it too safe, the problem won't be resolved by making tall claims on pumping money in equities. Come June and you will again stow away your bonus in yet another fixed deposit. Instead, experiment with small steps towards higher risk. Invest in instruments that combine equity and debt. Pachisia says balanced funds are a good option as they invest 35 per cent of the money in debt instruments and therefore carry less risk than equity funds.
Index funds are also suitable for your risk profile. These funds replicate the distribution of stocks in an index which removes the errors of active money management.
Your investment grows with the benchmark index.
Besides, shift from traditional insurance policies like endowment plans to pure term plans and Ulips. Term plans offer protection at a very low cost, whereas Ulips combine cover with market investments. Here, too, you can choose the mix of debt and equity suitable for the risk profile of your age.
In the final stage of risk evolution, move to hardcore market investments via diversified equity mutual funds. These funds are one of the safest ways to invest in the market. If you select good performers, you needn't review them more than once in six months or so. Thus, you are unlikely to come face to face with short-term, insomnia-inducing volatility.
At the other end of the risk scale are people who thrive on the adrenaline rush of high volatility. Unmindful of risk, an ultra-aggressive investor is one who will increase the stakes in the roulette till his luck lasts. Pachisia claims that very little reins in such risk addiction. "I am not sure that they aim for wealth creation at all. They seem to seek only the excitement of making big bets on the market," he says.
Such investors do not understand the enormity of their mistake. When they make too much money, greed overcomes rationality. It is only the moment that counts, not the future. Often, aggressive investors are forced to take debt to invest more and make up for previous losses. This is a blunder. Unfortunately, it is only when they have lost all the money that reality sinks in.
You might be playing with risk aggressively, but being left with no money is hardly the fate you aspire to. So, if avoiding high risk is impossible, at least invest in safe havens alongside. You probably do not have the will power to voluntarily allot a part of your surplus to such investments. Therefore, take the automatic transfer route to put money in debt investments like fixed deposits. Another option is to give some money every month to a family member or a friend who can invest in a safe instrument.
Also, make sure that you have covered your dependants adequately. Opt for term plans that have no investment component and, therefore, no lure of returns. Similarly, buy health plans so that even if you have been bled white in the market, there is money to deal with emergencies.
Though they take extreme stands on risk, both conservative and aggressive investors have the same lesson to learn: a middle path to prosperity exists. As mentioned earlier, it is not possible to change their personality traits. However, they should try to be more receptive to advice that leads to this path.
