Risk and time are two important considerations in any investment decision. They are the ingredients that help you reach your financial goals. Therefore, it is important to know how they play off each other. Understanding their relationship can help you achieve financial goals over time. So, let’s get down to understanding the jugalbandi between risk and time in the investment world.
✓ Short-term goals
Every investment carries different types and degree of risk. Investments like short-term bonds carry minimal risk for an investor with a short-term goal. With a shorter span of time available to achieve goal, you would prefer an investment with less risk and more stability. Capital protection would be more important than a high return expectation here. On the other hand, investing in less riskier investments like short-term bonds or cash would be a riskier option for someone who is saving for retirement, a goal that has a longer time horizon. Such investments may not deliver inflation adjusted return.
✓ Long term goals
Goals with a longer time horizon need you to take considerable amount of risk to get the potential return expected. Aggressive investment vehicles like stocks, equity mutual funds and real estate are some of the investment vehicles that can help you in the long run. Yes, aggressive investments are more volatile and risky. But historical data suggest that the risk element usually wears off over longer term. Basically, a longer time horizon can help your investments ride through many market cycles. The reasons for this are manifold. Some of them are:
1. Rupee Cost Averaging: High the volatility, higher the advantage. Higher the time, higher the chances of averaging the cost. It works in both rising as well as falling markets.
2. Higher risk can be taken with longer tenure so that there is time to make up in case of loss of wealth in the interim.
3. Risk can also increase with time for debt funds:
a. Interest rate risk- Duration funds have higher risk than accrual ones
b. Credit risk
c. Reinvestment risk-
d. Liquidity risk
This simply means that each investment has some inherent risk attached to it which gets affected with time. Bank fixed deposits (FDs) have reinvestment risk that comes at the time of maturity of the FD and not before that. So, in a falling interest rate situation like now, FDs need to be booked for a longer tenure to gain in the long run.
Similarly, even interest rate risk and liquidity risk need to be evaluated over time. For properties, there is an element of liquidity risk in an emergency situation when money is needed immediately and there is little time. That’s when you may face problems of finding the right buyer.
Investment and risk are two sides of the same coin and accepting one means accepting the other. However, most people think risk is only market risk but actually each and every investment has some risk associated with it. For instance, bank FDs carry reinvestment risk and interest rate risk, equity has a market risk, while Public Provident Funds (PPF) can have interest rate risk and liquidity risk
To sum up, the investment’s timeframe and risk management need to be calibrated deftly to achieve long-term financial goals.
Disclaimer: "Investment in securities market are subject to market risks, read all the related documents carefully before investing."
Time plays the biggest role in successful investing
Time is a key factor in your success as an investor. With endless choices of investment options available, it’s quite complex to make the right choices that can contribute to successful investing. So, to make it work for you, one of the most important question to be considered is, ‘’what is your time horizon to achieve your end goal?’’. The answer can help you to major extent to decide on best suitable investment vehicle.Time can affect your investment in multiple ways. Let’s take a look at the investing guides.✓ Risk and time The risk tolerance level is affected by element of time. Let us understand this with an example. Let’s say you are planning for retirement which is several years away, then you can afford to invest in relatively risky and high-return potential assets like equity . That’s because you will have enough time to overcome market volatility. In case you have a shorter time span, say about two to five years, then you may want to go with investments that are stable and less risky, even if the returns are lower. ✓ Growth potentialThe power of compounding takes time to work. So, the longer one remains invested, the better it is. Let’s illustrate this point with an example: A monthly investment of Rs 10,000 at 12% rate of return amounts to: So, it can be easily seen with systematic investment of Rs 10,000 per month over the years, the amount compounds very fast when the number of years invested are high. ✓ Targeted objectiveGoals keep changing with age, change in lifestyle, etc. So, it’s important to start investing early to build successful portfolio. Goals can be both short term and long term. The timeline of your goal helps you choose the right investment option. For instance, if you have a short-term goal like buying a car, it is best to invest in debt. On the other hand, a long-term goal can be achieved by investing in stocks. You may say that stocks are risky but time generally has a calming effect on them. Give your stock investment some time to breathe and you’d see the famed volatility subside. The up-and-down nature of stocks usually tend to flatten in the long run. To surmise, time is one of the most important factors that affect investment decisions. It is also the catalyst to see your money multiply. What’s Next?Returns are a very important factor in investments but it is not the be all and end all. It needs to be weighed with risk and then chosen. However, return is the one factor that can be explicitly measured and thus plays an important role in our investment decisions. Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
Do you know how to invest?
Do you know how to invest? Take this quiz to find out 1) You are planning to buy a house in the next 10 years. The most efficient way to reach this goal is to:a) Put your money in a bank savings accountb) Invest in the stock marketCorrect answer: (b)Buying a house is a costly affair. Investing in the stock market can help you earn much higher returns compared to a bank savings account. In addition, since this is a long term goal, the risks are also considerably reduced.2) What is a prospectus?a) It is a legal document that is issued by companies offering securities for saleb) It is a document that lists out the future prospects of a companyCorrect answer: (a)A prospectus is a legal document that each company has to issue before at the time of an Initial Public Offering (IPO). It contains important information such as the company’s financial details, its risks, opportunities and future goals.3) Your friend tells you that investing in stock X will double your returns in 3 monthsa) Invest in the stock right awayb) Research the stock carefully before you consider investing Correct answer: (b)Unsolicited tips in the stock market are very common. That doesn’t mean they are right. Never invest based on tips. Always do your own analysis before putting your money on a stock. 4) Swati is a risk-averse person. It is better for her to invest in:a) Mutual fundsb) StocksCorrect answer: (a)For a risk-averse investor, it is better to invest his/her money in mutual funds. The returns may not be as high as stocks but they offer greater security to invested capital compared to stocks.5) The stock market has taken a major downturn. You shoulda) Immediately sell all your stock holdingsb) Wait and watch before you take any hasty actionCorrect answer: (b)The stock market can be very volatile. But that does not mean you take out your investment every time the market sees a downturn. If you are a long term investor, it is best to wait and observe why the market crashed. If the reasons are only temporary, you can wait until the market regains its upward momentum.6) Which of the following is false:a) Diversifying your investment portfolio helps you minimize your lossesb) Short selling is a process of selling a stock first with the intention of buying it later at a lower pricec) It is possible to predict future price of a stock based on past price movementsCorrect answer: (c)The future price of a stock is not determined by its past performances. As a result, it is not possible to predict a future price based on past patters. That said, it can be useful to study the past performance to gain a better understanding of a stock. 7) Girish wants to create an emergency fund. He should consider investing in:a) Short term debt fundsb) Stock marketCorrect answer: (a)For an emergency fund, it is best to invest in short term debt funds. These funds offer high returns and they are easily accessible. You can withdraw the money very quickly in case of an emergency. But most importantly, they offer higher degree of capital protection compared to stocks.8) Geeta is retiring in 5 years. Currently she has 80% of her investments in the stock market. a) She should retain her investments in the stock marketb) She should slowly transfer her funds to less risky investment avenuesCorrect answer: (b)Investments in the stock market offer high returns. But as a person nears retirement, it is safer to transfer the funds to more stable investment avenues such as debt funds. You don’t want to risk losing a major chunk of your investments when you are about to retire. 9) When you buy a bond issued by a company:a) You become a part owner of the companyb) You lend money to the companyCorrect answer: (b)When you buy a bond, you are basically lending your money to the company. In return, the company promises to pay you a specific sum of money as interest. And at the time of maturity, the company returns your money.10) The stock market in India is regulated by:a) The Reserve Bank of India (RBI)b) The Securities and Exchange Board of India (SEBI)c) The Insurance Regulatory and Development Authority of IndiaCorrect answer: (b)In India, SEBI is the designated financial regulator body. It enforces regulation in the investment markets and maintains an efficient and stable environment in the financial markets.Final score:How did you score?0-3: you may want to brush up on your knowledge on investments4-6: Good start. You do have a fair bit of knowledge about investments. But try reading more on the subject to become an expert investor7-9: Great going! You are nearly there.10: Excellent performance. You are now a stock market superstar. Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
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