Lets start with basics. What is Investing?
Making Money Work for You. So, if you are getting any returns from your money then it’s invested. So, money in any form except cash is investment like Saving Account, FDs, Gold, Mutual Funds, Shares, etc.
And, what is risk?
Risk as we know is deviation from expected. But while investing it’s actually the possibility of losing your hard earned money. Also, returns always comes at the cost of risk.
Most people feel that investment is risky and hence they keep their money in Saving Account or FDs. But these are also kind of investments. These are actually most unsafe investment as you are bound to lose money in real terms (returns minus inflation).
To make above point further clear. Let’s look at different types of investments and their performance historically and evaluate their returns and risk.
Fig 1: ₹100 invested in 1985–86 in Gold, Sensex and Fixed Deposit
This is pretty clear from above chart that investing in Equities gives much higher returns that Gold/ FD but risk also high.
Table 1: Real Returns from Sensex, Gold and FD in various scenarios
Also, another data point is that if we consider inflation, the returns for FD are almost nil and it is also risky as inflation sometimes is higher than returns.
Fig 2: Returns from FD in various scenarios
Considering, FD rates are ~7% today, in all cases FD will give your negative returns hence risk is 100% and returns are also ~zero. Saving Account is even worse as you get even lower returns. So the point here is that Saving Account and FD are actually most risk as chance of losing real money is ~100%.
Every investment options comes with their risk and potential returns. The trick is to make these things work for you in the best possible way.
Tricks for safe investing:
I analysed historical data for all asset classes to find ways to reduce the risk and still get good returns. I am calling them tricks that anybody can use to make their investment safe.
Trick 1: Start safe
You should start with low risk investment options and gradually increase the risk. This might look counter intuitive to other rules like ‘100 Minus Age’ (always invest 100-Age percent in equities) but its more practical.
We are more driven by emotions than logic but you can use logic to manage your emotions. So, most investors give up investing when they lose money. if you are want to stay invested start with safe investments like debt funds. One example, that can substantiate this, is that there are ~1 Crore investor with demat accounts but only 10% of them actively invest and most often than not the reason is they have burned their fingers in the start.
Fig 3: Different Types of invest options with nature of risk and returns
Debt mutual funds (Liquid, Short Term or Long Term Debt) is a good starting point as you will not lose money and you can start investing in riskier options once you earn some reasonable returns from debt funds. Also with time, investors can learn to manage their emotions and take better decisions.
Trick 2: Diversify and Invest in Portfolios
First of all, Investing via mutual funds instead of directly investing in securities has multiple benefits like
- Diversification as mutual funds invest across securities
- Time saving on selecting right securities
- Liquidity with option to withdraw or invest any amount anytime
But still every mutual fund is constrained by its investment objectives and strategy. So, just investing in mutual fund is not sufficient.
By using concepts of Modern Portfolio Theory (MPT), diversification across investment options can help you generate same returns at lower risk.
Fig 4: Returns of Gold only mutual fund v/s portfolio of Gold, FD and Sensex
Above example clearly shows that you can reduce risk by ~50% or increase returns by 20% by creating portfolio of all three securities than investing in just one. Will provide more examples in further blogs.
So, invest in portfolios to reduce risk or increase returns.
Trick 3: Risk reduces with time
- Longer the period lesser chance of loss
Fig 5: Probability of loss with time period of investment in Nifty
Above example clearly shows that probability of loss goes exponentially down with time period. After 10 years, it goes down below 5%.
- Longer the period lower the risk
Fig 6: Rolling returns of Nifty for last 20 years
Above example clearly shows that maximum loss goes exponentially down with time period. After 10 years based on last 20 years, you can’t lose money.
So, if you invest in equities invest for long term to reduce risk.
Trick 4: Choose Wisely
Last but not least, choosing right product make above tricks happen is very necessary. So, don’t just look at only returns to choose the right product.
Always look at three basic things
- Risk and Returns: Look at returns always along with the risk associated with those products. One quick thumb rule is returns should be greater than risk.
- Track Record: Nobody can predict future but history can give you some benchmark to estimate it and age show tells you about survivorship. So, look for consistent historical performance and some decent size.
- Fees & Charges: Returns are historical while fees like expense ratio are predictable for future. So always be cognisant of them.
Fig 7: A snapshot on mutual analysis
with courtesy of groww.in
There are no free lunches but you can find ways to make it cheaper. Similarly, every investment has risk but your can reduce risk by adopting above tricks.