Risk and return two sides of a coin. Invest wisely, minimize your risks and let your money grow.

There is a very famous saying about investment and that is: Investment is very easy even monkey can do it. How? Very simple: buy at low price and sell at high price. However, it is not that simple. The fundamental question is how we know this is the lowest price and that is the highest price. If it is that simple all of us would be the billionaires.

The world of investment can be extremely attractive especially when we hear that someone (may be our relative and/or friend) has made lots of money from the share market. But make no mistake, investment is very complex. In this context we need to remember that there are many different ways that one can go about making an investment. Investors today have more investment options than were available to average investors just a few decades ago. While having multiple options is usually a good thing, too many options can cause information overload and lead many people to avoid making decisions or taking wrong decision. Investing is a broad topic that often seems intimidating to people who are new to investing. And that is understandable – there are dozens of investment vehicles, hundreds of investing strategies, and many investment options. As a result many people don’t invest because it seems overly complicated. But if we want to build wealth, investing is one of the main options to do so. But lets’ be clear that the stock market and greater financial world won't seem so complicated once we learn some of the lingo and major concepts. Therefore it is a good idea to be familiar with some of the basic concepts of investments.

many people don’t invest because it seems overly complicated. But if we want to build wealth, investing is one of the main options to do so. But lets’ be clear that the stock market and greater financial world won't seem so complicated once we learn some of the lingo and major concepts.

 

Most people choose from four main types of investment, known as ‘asset classes’:

  • Cash – the savings you put in a bank
  • Bank Deposits
  • Fixed interest securities (also called bonds) – you loan your money to a company or government
  • Shares – you buy a stake in a company
  • Property – you invest in a physical building, whether commercial or residential
  • Gold
  • Silver
  • Insurance
  • Others

The various assets owned by an investor are called a portfolio.

As a faculty of finance in Kathmandu University School of Management (KUSOM), lots of my colleague, friends, relatives frequently asks my suggestion about investing their savings in different securities mainly shares.  Most of the time their concern is about how much return they can get from their investment while ignoring the second most important part of investment i.e. risk. Investment goal must be expressed in both return and risk. Our return in investment primarily depends upon how much risk we want to take. Therefore, let’s briefly discuss about return and risk.   

 

Return

Returns are the profit you earn from your investments. Depending on where you put your money it could be paid in a number of different ways:

  • Interest (from cash deposits and fixed interest securities)
  • Dividends (from shares)
  • Rent (from properties)
  • The difference between the price you pay and the price you sell for – capital gains or losses from gold, silver, shares properties and others.

 

Risk

None of us likes to gamble with our savings but the truth is there’s no such thing as a ‘no-risk’ investment. We are always taking some risk when we invest, but the amount varies between different types of investment. This is true even in our bank deposit. Money we place in secure deposits such as savings accounts; risks losing value in real terms (buying power) over time. This is because the interest rate paid by the bank won’t always keep up with rising prices (inflation). For example, let’s assume that I get 7% interest on my saving deposit from my bank. However, our inflation rate is 12%. Therefore, I am not earning 7%, in reality I am loosing 3%. Because my return that bank is offering me is less than the current rising in the price (inflation rate) of the country. In Nepal, in general, return from bank deposit is less than inflation rate. Therefore, we are losing rather than earnings from our saving and or fixed deposit.    

Stock market investments may beat inflation and interest rates over time, but we run the risk that prices may be low at the time you need to sell This could result in a poor return or, if prices are lower than when you bought, losing money. When you start investing, it’s usually a good idea to spread your risk by putting your money into a number of different products and asset classes. Let’s discuss this in more detail below:

If we own different securities (asset classes) like shares, bank deposits, bond and gold, we are holding a diversified portfolio. As a general rule, spreading our money between the different types of asset classes helps lower the risk of our overall portfolio. For example, let’s assume that I have made an investment in shares, bond, gold, real estate and bank deposit. If  for some reason, real estate price starts to fall, I will not be that much worried because stock prices of my shares may be rising, which may offset the loss from the real estate. However, if we hold only one asset class (security) like shares of “A” class commercial banks, we are highly concentrated. If something goes wrong in the banking sector, our whole investment can be wiped out. Therefore, in general, it is advisable to hold a diversified portfolio rather than concentrated one.  

If we own different securities (asset classes) like shares, bank deposits, bond and gold, we are holding a diversified portfolio. As a general rule, spreading our money between the different types of asset classes helps lower the risk of our overall portfolio

How to select assets class

Few months back, one of my neighbor who is around 60 years of age approached to me ask me to suggest him some name of the companies so that he can buy their shares.  Investment in shares is inherently risky than other securities and it is not advisable to invest all your savings in only shares especially when we are at 60s.  Therefore, the question is how to choose securities or assets class/es for our investment?  Choosing assets class (securities) for investment primarily depends upon followings:

  • Our age (Investment areas and objectives changes with the change in our age)
  • Our investment goal (what is the return that we are expecting from our investment? Do we want short-term cash for something like a car, or do we want to invest our money long-term for something like a college fund?. We should also decide whether we want to work with a professional broker or financial advisers who can help us create our portfolio?)
  • Our risk taking capacity
  • Our time horizon  (how long do we want to invest i.e. for 10 years, 20 years? Or we want to buy and sell frequently which is a general trend in Nepal?)
  • Our liquidity i.e savings (how much saving we have now and how much can we save in future?)
  • Our general understanding of capital market.

In the world of investment, there are four phases i) accumulation phase ii) consolidation phase iii) spending phase and iv) gifting phase.  Accumulation phase is the early to middle years of working career and the age normally in between 25 to 40 years. This is the time when we are building our career and establishing ourselves. Generally in accumulation phase, investors can invest for long term and have a high risk taking capacity. During this time, we look for return higher than inflation rate. Similarly, consolidation phase starts from 40 years. This is the time when we try to consolidate our wealth that we have accumulated during our accumulation phase. In this phase is our risk taking capacity is slightly less than accumulation phase. Spending/Gifting phase – begins after 50 years (retirement).  This is the phase when we prefer cash dividend rather than capital gain and hence risk taking capacity will be very less.

Based on above discussion, choosing assets class for investment depends upon our investment goal, expected return, risk taking capacity and our age. Therefore, we need to analyze above factors before choosing any assets class for our investment. At the same time, we also need to change our portfolio with the change in our age and circumstances. For example, we may have invested 80% of our savings in shares and 20% in gold during our 30s. This is the time, when we can take higher risk and can invest for long term. However, this needs to be changed when we reach 40s because during the 40s our investment goal and risk taking capacity may change.  

We should emphasize, however, that investing isn't a get-rich-quick scheme. Taking control of our personal finances will take work, and, yes, there will be a learning curve. But the rewards will far outweigh the required effort. True investing doesn't happen without some action on our part. A "real" investor does not simply throw his or her money at any random investment; he or she performs thorough analysis and commits capital only when there is a reasonable expectation of profit. Therefore, be careful before taking any investment decision.