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."