can be risky, but not investing is even more risky. Sanjay
Matai, executive director, InfraSolutions India Pvt. Ltd.,
explains the different kinds of risk involved in investing
knows that investing can be a risky business. But, in
fact, not investing is even more risky, as inflation erodes
the purchasing power of your savings year after year.
It is, therefore, important to understand
different risks associated with investing
types of risk are more critical for a given asset class
investments match your risk profile
to minimise the impact of the risk on the returns
Credit risk is where the issuer of the security may default
or not repay the principal and / or interest. Let us assume
that you invested in a fixed deposit of a company. Later,
if the company is in financial difficulties, it could
delay or default on the payment of interest. It may not
even return the principal amount. There have been many
such cases in the past, including banks (especially co-operative
risk is affects mainly fixed deposits, corporate bonds
/ debentures, etc.
minimise credit risk you should choose fixed deposit schemes
or corporate bonds of only large and reputed companies.
Rating companies like CRISIL, CARE, etc, independently
rate many such schemes. Read these ratings to understand
how risky your investment is going to be.
Liquidity risk comes up when a security is not saleable
or tradable in the market. Your money gets stuck, creating
what is called an asset-liability mismatch.
investments have a lock-in period. Or, there is penalty
/ cost that needs to be paid in case you prematurely withdraw
your money. Suppose you invested in the public provident
fund (PPF) every year, as it offers high tax-free interest
and is also fully secured. The amount is locked in for
15 years. You would have a problem if in the interim you
suddenly needed money urgently, and didn't have any other
option available. You might then have to take a loan against
the PPF, which would come at an interest rate higher than
you are earning on your deposit. The difference between
the two interest rates is your cost.
risk is mainly associated with fixed deposits, bonds,
government savings schemes, etc. It can also happen sometimes
with mutual funds that make disastrous investment decisions
and what are known as 'small-cap' shares, which are of
lesser-known companies and, consequently, not traded in
may, therefore, be prudent to keep about three to six
months of your estimated expenses in a savings account
or other highly liquid options, which can be easily and
quickly withdrawn. This will, in most cases, help tide
over the emergencies and minimise costs that you may otherwise
have to pay. Only, before taking any such step, it would
be useful to calculate whether the cost of prematurely
liquidating a fixed deposit is higher or lower than the
amount of interest you will lose by keeping your money
in a savings account.
Market risk mainly affects freely tradable instruments
such as stocks, equity mutual funds, futures and options,
commodities, etc. The price of these securities depends
a lot on demand and supply, apart from the fundamentals
of the company concerned. They are highly volatile in
nature, and an investor can make huge gains or losses.
This risk is very easy to understand; most people are
quite aware that the stock markets are risky.
Over the long term, the equity markets have mostly given
good returns. But in the short term, they can result in
huge losses (or huge gains). To manage market risk and
make the best of equity investing, one should invest small
amounts regularly and over a long period of time. History
shows that this considerably reduces the chances of making
risk is investing in a bad stock, which will not do well
even if you hold it for a long period. For those who want
to avoid this and take advantage of diversification, mutual
funds are a better alternative to directly investing in
equity, especially for the small investor.
Changes in interest rates mainly affect returns from debt-based
instruments like fixed deposits, bonds, government securities,
debt-based mutual funds, etc.
us assume that you made a fixed deposit in a bank at 7
per cent per annum for three years. Six months down the
line, if the interest rates increase, you would not be
able to take advantage of this as you are already locked
in for three years. Conversely, if the interest rates
were to drop, you would be better off. Say you invested
in the PPF a few years back and were earning 12 per cent
interest. Since then, the government has reduced the interest
rate in stages to 8 per cent. But you are locked in for
15 years in the PPF scheme, and have to accept the lower
need to be aware of economic developments and accordingly
make investments, so that you can take advantage of interest
rate movements. If you feel that interest rates will rise
in future, go for shorter maturity deposits. If you feel
that interest rates will fall, take three- or five-year
deposits. Or, if the interest rates are very volatile,
you can choose floating rate bonds, so that you continue
to earn market-linked returns.
aware of the risks you are taking when making investment
decisions. Then match these risks with your risk appetite,
and investment objectives, before you choose the option
that best suits you. This will ensure that you manage
risks well and get the best returns from your investments.