Risk management: Important aspect of financial planning

In an interview to CNBC-TV18, Hemant Rustagi of Wiseinvest Advisors explained the importance of risk management in financial plan of any investor.

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Below is a verbatim transcript of the interview:

Q: Despite the marked improvement in the way investors plan their investments, many of them still do not pay attention to risk management. How should an investor think of risk management?

A: Risk management should ideally be the focus point of any investors' financial plan. However, unfortunately there are number of investors who do not focus on this very important aspect of their investment process.

Usually, investors have to manage two types of risks. One risk is to the investment that they make.

Second is the risk of any financial distress to the family member in case of an unfortunate event of a death or a disability.

As far as the investment risks are concerned, there are broadly four types of risks that an investor need to manage. Firstly, there is a performance risk. Every investor portfolio has a mix of securities and they tend to behave differently over different time periods. This obviously over a period of time have an impact on the portfolio return. So to minimize the impact of these non-performing securities on the portfolio, it is very important for every investor to have a diversified portfolio. So diversification is the key here.

The second risk is the volatility risk. There are asset classes like equity and to an extent even gold, which have the potential to do very well over the longer period. However, for an investor to benefit from the long-term potential of these asset classes they have to manage the risk of volatility in the medium-term and short-term, which can be done by a systematic investment. So disciplined investor can benefit over the long-term.

Third risk is the risk of inflation. This perhaps is the biggest risk for any long-term investor. Therefore, the asset allocation has to be such that it should be able to beat inflation over a period of time. It is equally important to invest in those instruments, which have the potential to provide tax efficient return. So that investors can earn positive rate of return on consistent basis. This is where I think options like mutual fund score over others.

Caller Q: Can you tell me more about Term Insurance? I am earning Rs 25,000 per month, I can invest over Rs 3,000 per month. Please suggest options.

A: Term Plan is basically a pure risk cover kind of plan. It is very different from usual traditional plan like money-back or endowment plan where at the end of the period you get some money.

This is a pure risk, which means that even if you survive the term, you will not get anything back but in case something were to happen to you during this term then the beneficiaries will get the amount of risk covered.

The major benefit here is that these plans are much cheaper in terms of premium that you pay and you can get much bigger risk as compared to the traditional plan. So, yes you are doing the right thing that you are going for a Term Plan, which is an ideal product as I mentioned earlier.

For your kind of income, if I apply the thumb rule, you will require Term Plan of around Rs 30 lakh. At your age it should cost you somewhere around Rs 5,000-5,500 per year. Some of the Term Plans that you can consider here is ICICI Prudential icare or HDFC Click 2 Protect. These are two policies you can check and then go ahead with this.