Lower the Risk, Higher the Return

Yes, you read it right. When it comes to Stock investment, the theory of

“higher the risk, higher the return” is flawed

Let’s delve deeper into the perception of risk and find out if you really need to take on a higher risk to generate higher returns.

The Story goes like this…

Both, Mr. RiskTaker and Mr. Bond decided to buy a plot, for investment purpose only. Mr. Bond did the following research before finalizing the property:

• Shortlisted a Developer based on past track record, which included the following

- Timely delivery of past projects

- Development work as per promise in past projects

- Number of projects and the years in business

- Brand/ Reputation in the market, in the eyes of a layman (by talking to friends/relatives)

• Got the documents of the township vetted by a Lawyer
• Read the Terms & Conditions himself and asked relevant queries to the Developer
• Visited the nearby townships, to check if the rates quoted by the Developer are competitive
• Checked the City Master Plan and read about upcoming Government projects in the area
• Checked bank approval for a loan on the property
• Showed the shortlisted plots to a Vastu consultant, to finalise as per his/her advice

After doing the above exercise, he bought plot no. A-20 in one of the townships.

Whereas Mr. RiskTaker heard about the township from a friend, he visited the sales office of the township, got impressed by the Video presentation given by the Developer and bought plot no. A-21, on the spot. This plot is same as plot A-20, in terms of size, dimensions, direction, and the price.

Mr. RiskTaker has been investing this way since long and takes pride in taking High Risk. He claims, “higher the risk, higher the return”. In this particular case as well, he believes that he has made a high-risk investment and it would pay-off.

Whereas, Mr. Bond believes that he has made a low-risk investment.

Why do you think there is this difference in risk perception of both these investors, even though their investments are the same?

The answer is Research, which leads to Knowledge..!!

The perception of risk is low in Mr. Bond’s case as he did extensive research before buying, which gives him satisfaction and a sound sleep too.

After 10 years, both of them sold their plots and got good returns. Mr. RiskTaker took pride in the fact that he took high risk and therefore, got high returns. Whereas, Mr. Bond took a low risk and got the same high returns.

As an investor, would you prefer to be Mr. RiskTaker or Mr. Bond?

The story extends to Stock Market like this…

The same is the story with Stock Market (more commonly called Share Market). Interestingly, a significant majority of the investors in Share Market are Mr. RiskTakers. And the worst is, they are not even aware of this role being played by them.

India has hardly 6% of the population investing in Stock Market/Mutual Funds. And as per RBI data, these investors have less than 2% of their investable assets into Stocks. Compare this with the US, which has approx. 60% of the population investing in Stocks.

What do you think is the biggest reason for such low participation in India?

The Perception of RISK

Stock Market investment is perceived as highly risky and people have proofs for that – the proof is that the majority (maybe more than 90%) of us have made losses.

There are only 2 misconceptions because of which people lose money in the Stock Market:

1.    Stock Market is a quick money-making tool

"Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas."   - Paul Samuelson

2.    Stock Market Research is a part-time job

“The greatest enemy of knowledge is not ignorance, it is the illusion of knowledge.” - Stephen Hawking

What do Experts say?

When it comes to investing, there is no dearth of patience in Indians. We invest in PPF which has got 15 years ‘lock-in’; we invest in Insurance policies for 20-25 years; we have land/plot since our grandfather’s era. But the moment we invest in Stock Market, all the patience goes down the drain.

That brings us to the set of qualities required to make money in Stocks. Let’s see what the experts have to say:

“We have seen much more money made and kept by “ordinary people” who were temperamentally well suited for the investment process than by those who lacked this quality, even though they had extensive knowledge of finance, accounting, and stock-market lore.” — Benjamin Graham

“Success in investing doesn’t correlate with I.Q… Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.” — Warren Buffett

Stock Market investments are meant to be volatile. And it is this volatility (fluctuation in stock prices) which is perceived as a risk, by the investors. Here goes a quote on Volatility:

“Volatility is a long term investors' best friend.” — Warren Buffett

I would add my 2 cents to the above statement – “Volatility is a long term investors’ best friend, provided you have Knowledge and Patience” (Temperament is a more appropriate word for Patience).

For, if you have Knowledge and Patience, you would use Volatility in your favour. That is, you would buy more when the market falls. Whereas, if you do not possess Knowledge and Patience, the Volatility would act against you. That is, you would sell when the market falls and make losses. 

Think about it from a businessmen point of view. Let’s says you are into manufacturing and you get to know that the raw material prices are available at discount. In this situation, would you close your business or stock-up the raw material in your warehouse? Sounds like a stupid question, right? You would obviously buy more raw material.

Now apply the same logic to Stock Market investments. When a good Stock or Mutual Fund scheme is available at a discount, should you stop investing or buy more? This is easier said than done. The reason it is not easy to implement is, again - lack of knowledge and patience.

Safeguard yourself from the following habits

But before gaining knowledge or learning something new, most of us have to unlearn a few things. Make sure you keep a check on the following habits when it comes to stock market investments:

• Asking for Stock/Scheme Tips: Media (online and offline) is full of tips. And this is so because the investors are looking for the same. We often end up asking/looking/searching for Best Stocks to invest in, Top Mutual Fund Schemes, Multibagger stocks and so on.
• Short term Investments: Stock Market is meant for long term goals only. For short term goals, invest in debt instruments, like FDs, RDs, Debt Schemes etc. The long term here means at least 5 years.
• Trading Vs Investing: There is a huge difference between trading and investing. Trading is meant to be short term and is equivalent to gambling and speculating. Investing, on the other hand, is meant to be goal-oriented and based on research. It is interesting to see that every trader in the market calls himself/herself an investor. Being active in the Stock Market does not mean that you have to be active in trading. Rather, you have to be on your toes in your research. That is called being an active investor.
• Best Time to Invest: We often look for the best time to invest our hard earned money and this is where we lose out. Instead of waiting before you start the investments, have patience (and wait) after you have invested. The best time to invest is now, as long as you are investing for the long term. A very common question asked by investors is “Share Market ka kya haal hai”. Whereas, the appropriate question would be “Economy ka kya haal hai”. In the long run, the Stock Market of any country is a representation of its economy. If the economy grows, the stock market is bound to grow. 

So brace yourself for lower risk and higher returns…

Unlearn and Learn Everyday and soon you will arrive at the following ph(r)ase of life:

Higher the Knowledge, Lower the Risk, Higher the Return..!!

Happy Investing..!!

Anupam Roongta

www.anupamroongta.com