scorecardresearchHow to manage risk: Striking the right balance

How to manage risk: Striking the right balance

Updated: 08 Aug 2022, 11:56 AM IST
TL;DR.
Planning for a rainy day or contingencies is an extension of risk cover. At least 4-5 months of expenses need to be set aside for meeting any emergency needs. 
Time is money and hence the earlier you start and the more time you have, the better off your investments can be expected to be.

Time is money and hence the earlier you start and the more time you have, the better off your investments can be expected to be.

Why do we need brakes in a car? Well, well, a very basic question!!! We require brakes so that we can go on fifth gear whenever and wherever appropriate. For this same reason, many of my friends hit the gym with a zeal that impresses many; it allows them to binge on their favourite jalebi (Indian sweetmeat) or gobbles up innumerable pani puris (Indian snack).

It is this safety net or backup plan which allows them to proceed with their agenda, and take fair chances; not bothering to keep looking over their shoulder about the consequences of uncertainties in life, the uncontrollable.

To me, life is like a game of teen-patti (poker). We are ill-equipped to control the environment (the cards in circulation) and the cards held by other players, we can’t largely influence how our co-players read the situation, and we can’t do anything about the cards we receive.

What’s controllable is how well we play what we hold and how we can nudge or influence our co-players to believe in whatever we want them to see. And yet poker is considered a game of skill, as well as a game of chance. It is this play of randomness which makes it imperative for us to tread with caution and take chances, both at the same time. In short, take calculated risks.

Ideal risk exposure is about striking the right balance between what you get after paying what you do vs. what you reasonably need. Let me elaborate. High net worth individuals may not need to take risks, and ironically they are the best poised to take risks.

On the other hand, an individual with low inflows and huge outflows in terms of goals and responsibilities is not adequately equipped to take risks (risk and returns being the two sides of the same coin) but most needs it nevertheless. A delicate balance needs to be struck between the need to take risks and the appetite to stomach them. At times, not taking an adequate amount of risk could be the biggest risk taken.

Calculating the right amount of risk covered in a client’s life is an exercise in customization. It involves taking stock of one’s assets (excluding the one deployed for personal use), one’s goals and priorities, one’s lifestyle, and the kind of job one does.

Also, it involves out-guessing the probabilities of an occurrence at some point in time. Too much insurance would deny the current cash flows and too little might end up looking inadequate at the time of the happening event, which to begin with one is trying to insure against.

Similarly while planning for one’s investments (for the purpose of meeting one’s goals) the aim should be to beat inflation through the portfolio returns on a long-term basis, at least by a couple of percentage points. Doesn’t every client long for that elusive investment idea that would expose him to low risk and at the same time deliver to him good returns?

Investing in different financial assets namely, equity, fixed income, and commodities like gold (through ETFs) brings varied flavour to the portfolio both on the risk as well as returns front. Often, on a medium to long-term basis equity and fixed income take directionally opposite paths. It may be advisable to tag one’s immediate and medium-term goals to fixed income products and long-term goals to equity-linked products. Electronic gold, besides providing a hedge against inflation, acts as a safe haven in turbulent times.

Also, planning for a rainy day or contingencies is an extension of risk cover. At least 4-5 months of expense need to be set aside for meeting any emergency needs or in the event of a situation where the breadwinner(s) is not in a position to earn his/her remuneration.

For 30-year-old planning for his retirement at 60, the asset allocation across equity and fixed income can progress from 70% equity and 30% fixed income; tending towards 30% equity and 70% fixed income as he moves closer to retirement. An uncomplicated way of doing it would mean altering the asset allocation by 4% every 3 years for long-term goals like retirement. While this is a simplified solution, the asset allocation needs to be eventually customised to the client's goals.

Exposure to an asset class like equity, which can be volatile in the short to medium term, is an essential prerequisite to overcoming inflationary pressures (since the last 26 years NIFTY has seen compounded returns of 11%. This does not include money made from declared dividends).

More so, when some of us, born after the 70s, would be most likely cutting our 95th birthday cake, what with so many medical advancements? Our earning or accumulation years would be between 25 years to 60 years of age, and from 60 years of age, we are most likely to live till the ripe age of 95.

It is these 35 years that we would be living on our accumulated wealth (eating upon the capital and returns). We should ideally want our money to outlive us, not the other way round. It means for the 35 years that we work we need to set aside money for the other 35 years which would be lived post-retirement. We have no choice but to stay ahead of inflation.

We all slog to earn whatever we do. There’s absolutely no reason why our money should not work as hard as we do to generate optimal returns.

“Risk comes from not knowing what you’re doing.” – Warren Buffet

Deepali Sen is founder partner of Srujan Financial Services LLP (a Mutual Fund Distributor) and author of ‘Why Greed is Great!’

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First Published: 08 Aug 2022, 11:56 AM IST