Investment Risks

Investment risk is related to the probability of earning a low or negative actual return as compared to the return that is estimated. There are 2 types of investments risks:

1. Stand-alone risk

   This risk is associated with a single asset, meaning that the risk will cease to exist if that particular asset is not held. The impact of stand alone risk can be mitigated by diversifying the portfolio.

   Stand-alone risk = Market risk + Firm specific risk

   Where,

    

   • Market risk is a portion of the security's stand-alone risk that cannot be eliminated trough diversification and it is measured by beta

      

   • Firm risk is a portion of a security's stand-alone risk that can be eliminated through proper diversification

    

2. Portfolio risk

   This is the risk involved in a certain combination of assets in a portfolio which fails to deliver the overall objective of the portfolio. Risk can be minimized but cannot be eliminated, whether the portfolio is balanced or not. A balanced portfolio reduces risk while a non-balanced portfolio increases risk.

   Sources of risks

   • Inflation

   • Business cycle

   • Interest rates

   • Management

   • Business risk

   • Financial risk 

Return Analysis

An investment is the current commitment of funds done in the expectation of earning greater amount in future. Returns are subject to uncertainty or variance Longer the period of investment, greater will be the returns sought. An investor will also like to ensure that the returns are greater than the rate of inflation.

An investor will look forward to getting compensated by way of an expected return based on 3 factors -

• Risk involved

• Duration of investment [Time value of money]

• Expected price levels [Inflation]

The basic rate or time value of money is the real risk free rate [RRFR] which is free of any risk premium and inflation. This rate generally remains stable; but in the long run there could be gradual changes in the RRFR depending upon factors such as consumption trends, economic growth and openness of the economy.

If we include the component of inflation into the RRFR without the risk premium, such a return will be known as nominal risk free rate [NRFR]

NRFR = ( 1 + RRFR ) * ( 1 + expected rate of inflation ) - 1

Third component is the risk premium that represents all kinds of uncertainties and is calculated as follows -

Expected return = NRFR + Risk premium

Risk and return trade off

Investors make investment with the objective of earning some tangible benefit. This benefit in financial terminology is termed as return and is a reward for taking a specified amount of risk.

Risk is defined as the possibility of the actual return being different from the expected return on an investment over the period of investment. Low risk leads to low returns. For instance, incase of government securities, while the rate of return is low, the risk of defaulting is also low. High risks lead to higher potential returns, but may also lead to higher losses. Long-term returns on stocks are much higher than the returns on Government securities, but the risk of losing money is also higher.

Rate of return on an investment cal be calculated using the following formula-

Return = (Amount received - Amount invested) / Amount invested

He risk and return trade off says that the potential rises with an increase in risk. An investor must decide a balance between the desire for the lowest possible risk and highest possible return.

5 Major Risks of Retiring Early and How to take early retirement by overcoming them?

The Risks involved in thinking on “How can I get early Retirement?”

Dreaming on “How to take early retirement ?” or ““How can I get early Retirement?” seems fantastic. Just say goodbye to your work and pursue your passion, hobbies, engage in charity activities, travel or just sit and enjoy life. To retire at the prime of life and have freedom to do whatever you wish to do is seductive. There will be no more daily grind of rushing to office, meeting deadlines, office politics, and such stuff. But before you call it a day at work, think it over and again and make a decision on ‘at what age can I retire?’. Retiring early may ensue in lots of trouble if not planned properly for financial independence.

https://holisticinvestment.in/blog/risks-of-how-to-take-early-retirement/

What every investor needs to know about Capital Gains Account Scheme?

The Query

Mr Chaudhury has just sold his old ancestral house for a lump sum consideration of Rs.20,00,000. He has now set his eyes on a new apartment which is due for possession within the next two years. Mr. Chaudhury is in a dilemma, he is aware that the amount he has received is a Capital Gain in his hands and is liable to tax. His intention is to use this fund towards paying for his new abode. What are his options?

https://holisticinvestment.in/blog/what-every-investor-needs-to-know-about-capital-gains-account-scheme/

Regards

Ramalingam K, MBA, CFP,

Director and Chief Financial Planner,

Holistic Investment Planners

“Best Performing Financial Advisor Award” Winners from CNBC TV18

www.holisticinvestment.in