It was his life time dream and he has really worked very hard in this direction by saving small amounts at regular intervals. He had often heard people talking about investing money in certain financial instruments, whereby as per his understanding money grows at a faster pace.
As jargons of the financial markets are beyond Joseph’s understanding, he decided to consult his long time friend Rahim on the matter. Rahim is a practicing investment adviser and currently handles the portfolios of many high net worth investors in the country. Joseph, while waiting for the Rahim’s arrival, is dreaming to become rich overnight.
He is under the wrong notion that his life time saving of Tzs. 1 Million - once invested would grow at an astronomical rate, and soon would get translated into a big amount. Rahim without being aware about the mindset of Joseph commenced asking him certain standard questions.
As is the practice, such questions are required to be answered by a prospective investor before any investment adviser like Rahim provides a tailor made investment solution, which is based on the risk profile of an investor. In the process, Rahim dropped a bombshell by asking Joseph that - “Is he ready to take the inherent market risks as attached to certain financial instruments in order to earn comparatively better returns on his investments?”
Joseph was bit furious on hearing this, as he had never dreamt of losing a penny out of his precious money at any cost. Sensing the gravity of situation, Rahim requested Joseph to have some water in order to cool down tempers in the room. The moment situation was back to normal; Rahim took the opportunity of narrating some basic rules of investment to Joseph.
First he explained the difference between “Savings and Investment”. He told that savings and investment are often used interchangeably; however one’s savings may not necessarily be one’s investments. Funds set aside for future use can be termed as savings.
Rahim kept explaining that cash set aside or left lying in a savings account thereby earning a nominal return is savings. Investments on the other hand refer to funds that are put to use with a purpose of earning returns and are often made with a specific purpose. After having explained the difference between savings and investment, Rahim switched to another subject relating to “Risk vs.
Return” on investments. He stated that the most common characteristics that a novice investor like Joseph wants in an investment product is that it should have no risk but with a potential of generating very high returns. Quite different from this point of view, seasoned investors however are aware that returns on an investment product are always commensurate with the risk taken by the investor. Higher the risk taken higher is the probability of returns from an investment.
Rahim reassures Joseph that behavioural pattern of ordinary investors is quite a risk averse, meaning that given two assets that offer the same expected returns, investors will always prefer the less risky one. Thus, an investor will take on increased risk only if compensated by higher expected returns.
Conversely, the investor who wants higher returns must accept more risk. The exact trade-off will differ from one investor to another based on an individual’s risk appetite levels. After intently hearing Rahim’s narrated basic lessons on investments, Joseph was fully convinced that risk is an integral part of any investment transaction.
Moreover, without being ready for risk, it is futile to expect comparatively superior returns on one’s investments. As the saying goes - “no pains no gains”, hence on the similar lines one should be ready to take certain calculated risks in order to earn comparatively better returns on his/ her investments. However, efforts should always be made to minimise the inherent market risks while working towards maximization of returns.