Vivek Sharma
The perception of risk in investment varies substantially for investors. Some investors feel that they are insulated from risk as along as capital invested by them is safe, while some others feel that if they are able to get back capital plus some assured return offered to them, they have managed risks successfully. The risk is most identified with default risk by the investors, which is nothing but the ability of the issuer of an instrument to honour the commitment of payment on time. This is the reason investors’ generally perceive equity and mutual funds are extremely risky as both capital and return on capital are subject to so many conditions, while they perceive investments into traditional products such as PPF, NSC as safe. While this perception is absolutely fine as far as risk is considered, what is often missed out by the investors is the risk that some time tested debt instruments offer.
One of the wrongly held notions about risk in government backed investments assets is that they are completely insulated from risks. While default risk may not exist in some of these instruments because government (some of these cases) has the mandate to print currency notes, the risk in these traditional debt instruments still exists. Risk in investments goes beyond the concept of default risk or risk of delayed payment of coupons. Risks may also arise because of factors such as reinvestment risk and the risk in obtaining real return from investments in these products. In order to understand this better, let us have a look at some of the traditional investments products and the risks that they pose.
Investment Assets Default Risk Reinvestment Risk Other Risks
| Investment Assets | Default Risk | Reinvestment Risk | Other Risks |
| PPF | Does not exit, as currency notes can be printed by the GOI. | Yes, rate of interest is set every year as per recommendation of Shyamala Gopinath Committee and is based on 10 year G-Sec yield. | Is subject to inflation risk which can make real return low. |
| NSC | Does not exist, as currency notes can be printed by the GOI. | Does not exist, as it is like a zero coupon bond and entire proceeds are paid on maturity. | Is subject to inflation risk which can make real return low. |
| Inflation Indexed Bonds | Does not exist, as currency notes can be printed by the GOI. | Interest received from these bonds cannot be reinvested at the same rate. | It may not beat inflation as returns received are taxable and can be lower than the inflation. |
| Bank Deposits | There is a default risk existing as deposits only upto Rs. 1 lakh per bank across accounts of one individual depositor is insured. If government chips in to avoid systemic failure arising from a failure of a bank this risk can get reduced. | Reinvestment risk exits depending upon the type of deposit. However, saving account receipts cannot be invested at a lower rate. | Subject to significant inflation risk. |
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