The correlation between safety and returns

Most of us want higher returns on our investments but we often forget the presence of the inherent risk. In our pursuit to get higher returns we should not end up losing the entire investment. However, if we become too risk-averse than nothing great can be achieved, as you must have heard about the famous saying that “the biggest risk is not taking any risk”.

So when on money matters one must understand that there is always an element of risk. If you think that you are safe by not investing your money and instead keeping it safely in your cupboard, there is again an element of risk i.e. firstly without investment, your money will not grow, and secondly there is always a chance of theft, so losing the money altogether.

Whether you are a retail investor or the institutional one, first thing you would want to achieve is the fastest possible growth of your money? Everyone has two basic expectations – the first one is the ‘Safety’ and the second one is ‘Returns’. But remember they both are opposite goals. However, if one can act a bit sensible while taking investment decisions, we can achieve both in a balanced way.

By doing so, on one side your money will remain safe while on other side it will generate comparatively good returns. This is possible provided we follow the three core principles of prudent investment viz. (1) choose your investments carefully; (2) watch their performance regularly; and (3) take corrective actions when needed.

In spite of the above, normal human psychology of a common man drives him/her to make fast bucks within the shortest possible time. If we fail in managing this temptation of making fast bucks, for sure many a times we will end up making wrong investment decisions. One has to understand that investment returns are determined by many factors which among others would include – prevailing interest rates [for short as well as long term placements], economic outlook, future prospects and inflation rate etc. Therefore, one has to take into account such determining factors while expecting returns on their investments.

If we ignore these determining factors and look for getting super returns, it is quite possible that one would fall prey to many un-regulated and risky investment options, promising abnormally high returns to its investors. There are many examples of such mishaps across the world where many investors lost the base capital itself in their quest for getting super abnormal returns.

Thus, one has to be very careful while taking investment decisions on one’s hard-earned money. Every investment decision should be judged keeping in view the three important factors viz. Safety, Liquidity and Returns. While as an investor, it is quite customary to expect best returns in a prevailing situation, however here the ‘best returns’ means out-performance of the corresponding benchmark index of a particular target market and not super abnormal returns which remain nowhere near to the referred market index.

Now the mute question remains – as a normal investor how you would know the benchmark market index i.e. which one you should refer while making an investment decision. This is not very difficult to gauge if we know our target market. Suppose one is interested in investing in the equity market [i.e. listed shares], then the performance of the chosen stock over a period of time can be compared with the corresponding performance of the concerned Stock Exchange index.

Similarly, if one is interested in investing in debt instruments then depending on timelines the applicable benchmark index can be studied e.g. with regard to short term investments one can refer the prevailing rates on instruments such as: call rate, 182 days T-bills rate, 1 year bank deposit rate etc., while for long term investments the referred benchmarks could be the fixed term bank deposit rates or prevailing rates on a fixed term Treasury Bonds/ Corporate Bonds etc.

As an investor you must also ensure that the instruments/ schemes where you intend to invest are also regulated under the applicable laws of the country. The so-called Ponzi kind of schemes are normally not regulated by an appropriate Regulating Authority and thus bound to bring misfortune to the investing community. Some of these schemes are even outlawed in many countries. Therefore, before making any investment decision, gather desired information from the available sources so that your investment decision passes the litmus test of – Safety, Liquidity and Returns.

It is good to remember that in any investment transaction, return(s) is only one part of the story, while the other important factors like safety and liquidity of your investment should not be compromised in your quest for getting extraordinary returns. Notwithstanding the above, the role of an investment adviser or stock broker can’t be completely ignored, as their expert services can always be sought in order to make judicious investment decisions.

People think that earning money is the most difficult job in this world, however, managing the money well is equally difficult, as it requires a lot of planning and strategy so as to ensure that your money not only earns for you, but going forward it also remains safe. Cheers!!!