There’s no such thing as a risk-free investment. Your investments, and the returns you will generate from them, are shaped by different forces. When you trust an investment instrument with your hard-earned money, you should take cognisance of these risks and not be persuaded simply by returns-related risks.
Let’s take a look at some well-known risks:
Market risk: This is the obvious one, and one that investors focus most on. Market risks can be linked to volatility in the stock market, interest rates, commodity prices, or currency exchange rates. Before making an investment, you must consider your own risk appetite, and then decide if you’d like to increase or decrease your exposure to market-linked investments.
Inflation risk: Inflation quietly erodes the value of your money. When you invest towards a future goal, you must factor inflation into the calculation. You must invest in a mix of asset classes that provide returns higher than the prevailing inflation rate.
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Liquidity risks: Various investment instruments have lock-in periods during which they cannot be redeemed or can be redeemed with a penalty. This reduces the investor’s liquidity. Always maintain liquidity through savings accounts or bank deposits for short-term needs and emergencies. Additionally, have life and health insurance at all times.
Diversification risks: You may favour one form of investment, and put most of, or all of, your money into it. At some point, the cons of this form of investment will catch up with you. Never put all your eggs in one basket. Find a variety of investments to meet your short, medium and long-term needs.
Longevity risks: The question of how much to save and invest is always a difficult one to answer. It can only be answered through assumptions about the long term. Such assumptions can, of course, go wrong from time to time.
An investor retired at 60 with a life expectancy of 75 years, and hence had created a retirement fund to sustain himself for 15 years. However, he may experience a shortage of funds should he live well beyond the age of 75. The simple solution to this problem is to always live frugally within one’s means, maximise savings and investments, and create many appreciating assets.
The writer is CEO, BankBazaar.com