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Is Risk eating into your portfolio?

Published on Tue, Nov 07, 2006 at 10:31 | Source : Moneycontrol.com

Updated at Tue, Nov 07, 2006 at 12:11

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Recently I saw a poster of a movie named "Gafla"...The tag line of this movie read, " The biggest risk in life is not taking one". According to me "The biggest risk in life is taking one but believing you have not taken any" or "taking one but not understanding the consequences of your decision".

Too often we focus on the wrong set of parameters such as oil prices, stock prices, interest rates when it comes to making equity investments. People spend countless hours watching Business channels, reading magazines for hot tips, tracking the unknowns but there is hardly any time spent on the knowns, which is solely in your control. (Also read - Sensex @ 13K - How to play the markets now?)

I have shared some of the UNKNOWNS that we so often focus on and the KNOWNS that we ignore most of the time.

UNKNOWNS (This is NOT in anyone's control)

Sensex and Nifty Behavior
Stock Prices
Oil Prices
Interest Rates
Inflation
Tax Laws & Regulations
Geo Political Risks

KNOWNS (This surely is in your control)

My Needs and Goals
What is my time horizon?
What is it I want to achieve in Life?
How do I react to different things including Stock Market Ups and Downs?

In fact when it comes to investing, to be a winner, one must make as fewer costly mistakes as possible. A lot of people like to believe that they are better-blessed souls of our century who do not make mistakes. There is no one in the world of investing who has not made a mistake. The key point is to understand how to a costly mistakes. Getting back to my point, Understanding and Managing Risks are the most important parts of the investing process. Take too much Risk and you might jeopardize your financial future with huge losses. Take too little and you jeopardize your financial future with low returns barely enough to cover your lifestyle expenses.

So how do you determine how much risks you should take and are you taking enough?

First determine what returns you reasonably need to achieve your financial goals (Assuming that you know what your goals are). So if you need a 10 % return, why should you opt for some exotic thing like a derivative or trade like a maniac! I met a person recently who tracks the market day in and day out, devours every investment magazine and finally when the stock market closes, switches to the commodity market. Guess how well his portfolio is doing. From a value of Rs. 4 Crore it has come down to 2.8 Crore most of which I would attribute to a pinch of foolishness (with due respect) and a dash of arrogance. Second step is to figure out whether you are getting those returns consistently. Knowing your benchmark can help you a taking more risk than necessary. (Also read - Why should one invest in Arbitrage Funds?)

One of the investors that I know who believed that what has worked in the recent past will surely work for him again made an aggressive investment in F&O in May. But later, this is what he had to say "I had made 50 % returns in just 15 days but now I have lost 200% because of the leverage" said one investor. I will never invest in the stock market again". This is a common response like the one from jilted lovers who say "I will never fall in love again". Well I better not comment on the love factor but one thing I know for sure is that this mistake of not understanding the nature of the investment and completely blaming the asset class altogether does far more damage than anything else. At the end of the day "Failure is an opportunity to begin again more intelligently".

I have used an anecdote from the book the Intelligent Investor by Benjamin Graham that sums up my point "I once interviewed a group of retirees in BOCA RATON, one of Florida's wealthiest retirement communities. I asked these people mostly in their seventies - if they had beaten the market over their investing lifetimes. Some said yes, some said no; most weren't sure. Then one man said, "Who cares? All I know is, my investments earned enough for me to end up in BOCA". Could there be a more perfect answer. After all the whole point of investing is not to earn more money than average, but to earn enough money to meet your own needs. (Also read - Should Index funds be a part of your portfolio?)

As Ben Graham says "The best way to measure your financial success is not by whether you are beating the market but by whether you have put together a Financial Plan and a Behavioral Discipline that are likely to get you where you want to go".

In the end what matters isn't crossing the finishing line before anybody else but just making sure you do cross it.

Now how do you figure you are taking too much risks. 3 Simple questions might help.

Have I lost sleep during the May crash or in general after making the investments?
Do I feel pressurized to watch stock prices, fund NAVs weekly or daily?
Do the UNKNOWNs given above worry me about my financial future?

If you have answered yes to either of the above 3 questions, you have taken more risk than you can digest. (Also read - How to become a millionaire?)

If you answered yes to all the above, then like the kiddy line "it's time to put your toys away" - it is time to put some of your stocks/equity funds away. As F Scott Fitzgerald said, "If you don't know who you are, the stock market can be an expensive place to find out".

- Amar Pandit

The author is a practising Certified Financial Planner. He can be reached at amar.pandit@moneycontrol.com

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