Why shoulder Risk?

Investing is about earning a return in exchange for shouldering risk! Here is chart of Sensex yearly returns versus bank fix deposits yearly returns since 1979.

Variability of the return is one good measure of risk. Look at how volatile the returns in equity have been, many a times going deep into negative as well. Whereas the returns in bank fix deposits move in a narrow band. Investment in equity assumes far higher risk then that invested in fix deposits. Capital invested is at no risk in fix deposits whereas it is at risk in equity. But if you see the long term averages, fix deposits returns just barely keep up above the inflation. Whereas the average equity returns over long term beats inflation hands down. Wealth is created by beating inflation then compounding it!

So this explains the risk-return tradeoff. Potential return rises with an increase in risk. Low levels of uncertainty or risk are associated with low potential returns. Whereas high levels of uncertainty or risk are associated with high potential returns. According to the risk-return tradeoff, invested money can render higher profits only if the investor is willing to accept the possibility of losses.

Now that we understand that some risks have to be taken to create wealth, next logical question is how much risks needs to be taken? Need to take risk is determined by your financial goals and what rate of return is required to achieve them. Finanical goals & current resources would be key factors in deciding whether aggresive or cautious approach is needed.

Next logical step is to identify the ability to take risks. The level of financial risk that can be taken depends on current life situation. For example young single investor can take more risks, middle aged married investors has to take a balanced approach, while person close to retirement cannot take much risks. Stability of income, lifestyle, number of dependant's, savings, etc are also a key deciding factors.

Now if there is a need to take risks and also the ability to take it, in comes willingness. Willingness to take risks comes from life experiences and is largely settled by adulthood. Appetite for risk is not the same across all spheres of a person's life. An adventurous person, who loves mountain climbing, may not like to take huge financial risks. Conversely, someone who lives a very modest lifestyle may be willing to take on higher-risk investments.

It’s not only the head that determines the investment success! It’s also the stomach!! Its how the investor behaves after he/she has acquired the financial assets that has huge influence on the outcome. Risk tolerance is essentially the emotional capacity to withstand volatility and losses without panicking.

To conclude one has to understand the need, ability and willingness to take Risk, before shouldering it!

Disclaimer :- All investments are subject to the financial and market risk. Investors should re-assess information provided herein before investing. Mutual Funds are subject to market risk. Past performance may not be sustained in future.

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