7
Mar, 2015
Risk – What is Important?
In its “Investment Advisers Regulation” SEBI has mentioned the following –
Investment Adviser shall ensure that, it obtains from the client, such information as is necessary for the purpose of giving advice, including Risk Appetite / Tolerance.
We are following the above guideline strictly.
But at the same time we strongly believe that there are more to it. As far as Risk Appetite / Tolerance is concerned investors are mostly classified in three broad groups – Conservative – Moderate – Aggressive. But such ‘One size fits all’ strategy rarely works. Let us consider a few case studies –
(1) When ‘Risk Profiling Questionnaire’ is given to Mr. Sumit, aged 35, employed in an IT MNC, his answers revealed that he is a conservative risk taker. He wants to avoid equity, direct or indirect, as an asset class from his portfolio. His preferred assets are fixed return products. Now when his retirement goal is being planned it is found out that to achieve the goal following scenarios are there –
Current Age – 35; Retirement Age – 60; Life Expectancy – 85; Household & Lifestyle Expenses – Rs. 30,000; Inflation – 7%;
(a) Monthly savings or SIP required is Rs. 11,023 when expected return from investments is 15%.
(b) Monthly savings or SIP required is Rs. 19,030 when expected return from investments is 12%.
(c) Monthly savings or SIP required is Rs. 26,947 when expected return from investments is 10%.
(d) Monthly savings or SIP required is Rs. 37,596 when expected return from investments is 8%.
(e) Monthly savings or SIP required is Rs. 51,594 when expected return from investments is 6%.
Now, current monthly investible surplus in Mr. Sumit’s case is Rs. 20,000. The goal is also 25 years away from now. Should we recommend him to invest only in fixed return products?
(2) When ‘Risk Profiling Questionnaire’ is given to Mr. Amit, aged 35, employed in an IT MNC, his answers revealed that he is an aggressive risk taker. He prefers to invest in equities mostly. Now when his vacation goal, which is due in next 2 years, is being planned – should we recommend him to invest in his preferred asset class i.e. equity?
The logical as well as right answer, according to us, would be a ‘No’ in both the above cases.
So in practice, recommended asset allocation does not (only) depend on someone’s Risk Tolerance Level but mostly on the following two factors –
(1) Time Horizon along with cash-flow situation – When a financial goal is long term i.e. more than 10 years away from now, and cash-flow situation does not allow investments in low yield generating instruments – one has to go for equities. If invested with caution, and review is done at regular interval – equity as an asset class is capable of beating inflation rate with a good margin.
But when a financial goal is due in short term i.e. within 5 years, recommending investment in equities is not right, though investor’s risk profile may be aggressive.
(2) Knowledge – When you spend time in understanding an investment product i.e. how it works, what could be the best and worst case scenario etc. – risk reduces considerably. There is hardly any risk when a car is driven by an experienced driver, but there is a HUGE risk when that same car is driven by a 6 year old kid who does not know anything about driving. That is why over a period of time, when your knowledge increases of a particular product – your comfort level increases, risk reduces.
What do you think? Let us know your opinion in the comment section.