Sunday, 6 May 2012

The Risk Factor

Stock investments carry associated risk. As a beginner to stock market we should know about that risk and how to manage it. If a company in which you invested grows and makes profit then the market price of its shares will increase, thereby increasing the wealth of its investors. It is however possible that the company may not stand the onslaught of its rivals and may run into losses or
worst still, may go bust, or the company may under perform depending on global economic scenario and the country’s economic outlook. In this unfortunate situation the investors will have to bear the losses or lose their capital altogether. Now that is a risk.

In the stock market, any investment comes with associated risk. Therefore the money that is invested in the company shares is called risk capital. Investments in Fixed Deposits, Govt. Bonds and High rated Debentures by reputed agency are known as zero risk capital because in these financial instruments there is zero risk of losing the principal amount.

Why take the Risk?

Now the question that arises in the mind of every beginner to stocks, “Why on earth should I take a risk and invest in shares if I have other zero risk instruments as mentioned above? Isn’t it foolish?”.

It is not like we never take risk in our lives. We risked our careers when we chose one stream over the other during our education. We risked when we decided to work for a particular company in a different city from our hometown. We take risk when we decide to switch jobs for a higher pay package or other premiums. We take risk when we invest in a property under construction in the hope that we will have our dream home at a promised future date. We take risk when we go for a huge loan to cater to our needs with the confidence that we can repay it in due time.

Risk associated with investing in stocks should not be treated differently to any of the above. As beginners to stocks, we should be clear about this analogy.

True. FDs, Bonds etc. don’t carry the risk of losing the capital and also offer fixed return of, say, 8% per annum. Stock investments may give higher returns of 12% to 20% but have associated risk. There is however, one thing that needs to be accounted for. That single biggest determining factor is Inflation. Inflation results in increasing prices and increases the cost of living in general. Financial instruments like FDs that are risk free give low returns and cannot beat inflation in the long run. Investing in stocks and taking risk is necessary to beat this demon of inflation.

The Verdict :

The risk itself is not as dangerous as it looks at the first glance. If you invest after studying the performance of the companies and decide based on the knowledge of good fundamentals of the company then the risk is also reduced. There is a difference between an educated guess and a wild guess, and that makes all the difference in investments.

We have given some case studies of companies which have shown consistent growth in their sectors and are still relevant in their respective sectors. You can visit the section on Great Stocks to Invest, to know more.

However, RupyaGyan does not take any responsibility for any losses incurred to its readers. We only present our opinion and reader’s discretion is advised before investing in any companies. You can go through the Disclaimer for more information.

One more way for risk mitigation while investing is to diversify. The following table relating your age to the amount you should invest in equity and debt instruments is handy and can be followed as a rule of thumb.
asset allocation depending on age

This brings us to the end of this discussion in which we have tried to explain about the risk associated with the various financial instruments and how, by diversifying your investment into a combination of debt instruments and equity, you can mitigate the risk while earning handsome returns at the same time. Treat the risk in stock markets as similar to risk you take with any other aspect of your life. This is nothing different. Learning to invest is an art and investing in stocks can really be rewarding if done correctly.