Understanding RISK !!

Understanding RISK ! 

For any investor, knowing about risks is as important as knowing about returns. As a market saying goes "Take care of investment risks - the returns will take care of themselves !"

Risk, in a simple terms, means uncertainty that is related to any type of investments. Risk occurs when things don’t go as expected or goes in the opposite direction of what is desired. Also for an investor, risk could mean risk of a loss of trading income or many a times of the capital itself.

From an Investors point of view , there are broadly two types of risks:

1. Uncontrollable risk: The risk that is not controllable by the investors.
• Macro economic risks: It is the risk that is associated with the economy. Eg. Economy slowing down or in recession can affect the markets or any harmful/negative event that takes place like the terrorist attack, market scams is a macro economic risks.  
• Inflation risks:  A higher inflation can lead to rise in the interest rate and hence rise in cost of borrowing that can lead to slow down in the economy.
• Business Risk: A risk which is related to the Industry in which the company belongs. A loss of value of the company due to competition, mismanagement, and financial insolvency can be a Business risk. 
• Political/Govt Risks : Political risks are risks such as unstable government, or certain government policies or their control over various sectors can be unfavorable for the markets
• Market Risk: There may be certain risks which are market related or which arise due to the typicality of a market or its participants or it regulatory body. For instance FIIs may want to reallocate their investments in various countries and as a result may want to sell in equity market. This is a risk associated with the stock markets though macro factors may not have changed.

2. Controllable risk

Company-specific Risk: Company-specific risk is the risk related to the performance of the companies. If the company does not perform or may witnesses adverse business conditions, it in turn affects its overall profitability. This is a risk to the price of the share. However, this risk is controllable in the sense that the investor can diversify his investments in to various companies, so that a weakening of one company’s performance does not affect an investors total return to a large extent

In next article , we shall see how to control / minimize risks...

CA Rajiv D Khatlawala