How to understand the concept of risk?
Often people do not correctly understand what they are talking about when they use the word risk. For a trader risk is a potential loss and hence something called ‘risk’ exists for a gambler or trader or speculator. However, if you were an investor the word to consider is ‘volatility’ and not risk. As such any human endeavour carries a certain element of risk or danger. However, specifically talking when an investment is done with proper knowledge then there is only volatility and not risk. These words are not interchangeable. When people talk about investing in stock market they are referring to volatility which is inherent to such great wealth creating investments. So how does one have a transition of mindset from risk to volatility? One needs to appreciate that we are more worried if our capital fluctuates but we would not be so perturbed if profits fluctuated. Thus we must first allow for profits to get created which naturally require time, patience and skills. Thereafter, if profits fluctuated it would be alright and psychologically we would be at much more ease. At the end you can still take home a minimum of 14 per cent to 20 per cent average returns and much more each year totally tax-free. See how the word risk loses the undue importance given to it?
Any market, nationally or globally, has certain similar characteristics. There are booms and busts at regular intervals. The word ‘market’ itself means two views. Someone wants to buy and someone wants to sell. That is quite an irony, is it not? If something was good in someone’s view why would the seller sell it? Markets have their cycles and these cycles repeat from time to time. The length of such cycles differs from one category of asset to another. So once you know which category has created how much wealth, you can follow through and history will play out the way it has to taking care of your money as well.
Gaining more conviction, how?
It is very important to come to your own conclusion. For example, if you did analysis of, say, some FMCG company and came to the conclusion that this company has a great strategy and will continue to grow at 15 per cent for the next few decades; that is the safest, brilliant and a highly rewarding investment avenue that you have discovered. So then why fear putting more than 25 per cent of your money right into this? This way, in about 5-10 years time you would have converted your stock investment into a tax-free fixed deposit via dividends and capital appreciation. But all this comes out of knowledge and research which comes by investing in your own self i.e. investing in learning and building investment skills.
The greatest fear for most of us is not being able to trust ourself. We are our greatest enemy and not the stock market. Do not sell when you see a good investment is down by 20 or 30 per cnet. Don’t panic. Understand it is momentary and not perpetual. If you see prices going down, it’s a time to buy and not to fear and eject out of the investment.’ We pretty much know this but seldom implement it. You also know that if you sold earlier, you are probably still waiting to re-enter and will always keep waiting to re-enter. Likewise, if you sold at a 20-30 per cent profit, you are potential losing out the multipliers of future and hitting your head for the moment. Sell or switch from one investment to another when you have a better idea of what to do with the money on hand. Having fear is understandable but irrational behaviour happens due to lack of knowledge. Naturally this needs to be plugged.
—Author is Director, Transcend Consulting firstname.lastname@example.org