RISK, Are we really Understood what it is?

Here, I would like to say few RISKs about investments, hope this help us to understand about RISK much better than before.

In general, all the investors have the mindset that fixed return instruments are safe and RISK Free! 

To me RISK is not directly associated with the characteristics of the instruments and more associated with the tenure in which one investor is holding the instruments. In short, safe investment will be risky if it held long and risky investments will be safe if it is held long!!!

Some the fixed instruments are

1.     Fixed Deposit
2.     Insurance
3.     Public Provident Fund
4.     Pension Plans or Annuity Plans
5.     Gold

Risky Investments are
1.     Stocks
2.     Mutual Funds
3.     Real Estate
At the outset, whatever categorized seems to me okay, but if you dig little deeper then it will be totally reverse!

Let us see one by one

1. Fixed Deposit: Fixed Deposit is safe, if investor objective is one or 2 years, if it is more than 3 years, the instrument may be safe, but inflation is much bigger than the interest one earned post tax return. If somebody, putting 5 years in FD will be disaster. So FD will be highly risky, if it is held for 5 years plus.

2. Insurance: Generally, investor looks at this as a tax saving instrument along with that safe investment. It is generally long term product and in endowment policy, all the investments are in debt fund only, so it will not beat the inflation and also so many hidden charges. In case of ULIP, investor will never have the intention to stay long; even though it will surely beat the inflation, still investor will not stay back. Insurance investments are highly risky in terms of less liquidity, great loss when you surrender and if you keep it, till the maturity it will not beat inflation. It is also high risk investment which everyone tends to overlook!

3. Public Provident Fund, most of the investor will save up to 1 lakh and believe that it is a great investment because the maturity amounts are tax free. Any recurring investments for fixed return in a long term will never be a good option. Moreover, the rates are not fixed and it is market linked (nobody see this is a risk). If you look at the PPF return 10 years before it will be 12% and in the next 10 years the chance of coming down to 6% is very much possible. If you want to take money, then one needs to satisfy all the condition, and it is a 15 years product. At the outset, it seems to be good product, yet this might also fail to beat inflation or just beat inflation. But, the purpose is creating long term wealth, not to beat inflation for long term!!!

4. Pension Plans or Annuity Plans: Since, all the pension plans invest in debt instruments the returns will not be more than 6%. On top of it, if the individual requires a lump sum or 60% of their pension investment, in case of life threatening disease, the money will not be given. Just because there is no pension available from their employer it is highly dangerous to subscribe for pension plans. The returns are far inferior to inflation. Normal investment product will suit pension plans.

5. GOLD is generally considered as Hedge against inflation and it has given more than 15% return in the last 7 years. Main reason for the gold Bull Run is due to worldwide recession for the past 5 years and rupee is depreciated during that time period considerably. Going forward GOLD may match inflation return or it may not beat the inflation also in the future. May be 10% allocation is desirable.

Risky Investments

1. Investing in Stocks considered being very risky investments, if we trade on a day to day basis. If we buy stocks based on their business and leadership qualities and in a long run we can create huge wealth. Stocks are risky in a year or two, but,  3 years and above, it will be very good and very lucrative also.

2. Mutual Funds are less risky than stocks because it is managed by professionals. The returns are slightly lesser than the stocks, and it is also riskier when it is short term in nature and 5 plus years, it is always rewarded to their unit holders.

3. Real Estate is much riskier than any other investments and it is highly illiquid and one can't liquidate as and when it requires. Moreover, you can't sell partially, and it is location specific and capital gain taxes are applicable. Currently, there is big gap between the property price and rental yield and it is already over heated and moved many times in the past 10 years. Still, the investor believe that it is possible in the future also, which is the biggest risk they tend to ignore.

Hope the above points help you to understand what RISK is and not perceived RISK!