This is a good time to think about risk

by Manshu on January 28, 2011

in Opinion

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I’ve seen a lot of people compare the returns from fixed deposits, or bonds to shares in the past few days, and more than anything else this shows that people have been lulled into forgetting how sharply the markets can fall.

Before you say that the average return from a diversified equity mutual fund in the past five years has been 13 odd percent, so it’s better than a fixed deposit – remind yourself that a diversified equity mutual fund can go down fairly steeply, quite quickly.

And very soon you could be worried about return of capital, rather than return on capital.

If someone around you is talking about returns without talking about risk – remind them of the crash of 2008, and show them this picture.

The share market is inherently volatile, and it will be foolhardy to ignore this volatility, and talk about average returns.

Don’t talk about returns without talking about risk.

Now, one final thing about investing in debt.

It’s good to diversify your debt investments as well. In fact, there is no good reason to invest in the debt of just one company, or keep a fixed deposit in just one bank.

You could concentrate a large part of your wealth in one company’s stock hoping that it turns out to be a future Infosys, but there is no reason to invest a large part of your money in the debt of just one company.

If it goes under – you stand to lose all your money – and if it doesn’t – you still get the 10 or 11% coupon payment.

This is what some GM bondholders learned the hard way when it declared bankruptcy, so it’s better to learn from their mistake, and spread your debt investment as well.

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