Investment In Securities Market – Assessing/accepting Risk in Investment
as per Investor’s Risk Profile

Investment in securities are considered the most challenging as well as rewarding. But Investment in securities requires considerable skill and expertise and carries the risk of loss if the choice of securities is not right or they are not bought/sold at right time.

There are a large variety of instruments referred to as securities in common parlance. These are defined in the Securities Contracts (Regulation) Act, 1956 to include:

1. shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or body corporate;

2. derivative;

3. units or any other instrument issued by any collective investment scheme to the investor in such schemes;

4. security receipts;

5. government securities;

6. such other instruments as may be declared by the central government to be securities;

7. rights or interests in securities.

Different securities carry different risk-return profiles. Generally, higher risks carry higher returns and vice versa. The risks may take the form of credit risk (the counter party may default payment as it may not have integrity), the return risk (the return from the investment may depend on several contingent factors) and liquidity risk (it may be difficult to convert security into cash)

In the normal course savings generated are channalised to achieve finaqncial goals. But it may not be always possible to meet all financial goals with available savings. When savings are limited, the savings could be invsgted in aveues that would offer highreturns, tomeet needs that are substantial. But in this option, high returns also carry high risk. All investors are bnot in a position to carry high risks.

As discussed above, there are investment opportunities that are high on risk and there are investment opportunities that are low on risk. Each is called an asset class. An investor allocates his savings to one or more asset classes depending upon his circumstances. This decision is called the asset allocation decision. Asset allocation decision is perhaps the most important decision in the investment process. The essence of asset allocation lies in the fact that, over time, it can determine up to 90% of the portfolio's return.

How much risk an investor can take depends on his financial circumstances and the mental make-up. Every investor must know his own unique risk profile and then make the investment decisions.

• What kind of investor are you?

• Are you prepared to take high risks?

• Are you averse to taking risks?

There are scientific methods by which you can understand your risk profile. For example, answering the following set of questions could give an idea about your risk profile:

Your age i

• Between 25-35

• Between 35-50

• Between 50-65

• Above 65

Your position is best described by

• You are self-dependent and do not support anybody

• You have dependent(s)

• Nearing retirement

• Retired

How much of the following needs have been taken care of? (Fully, partially, not at all)

• Insurance

• Retirement

• Children’s education

• Housing

What proportion of your current expenses is funded from investments?

• Nil

• Up to 15%

• Between 15 and 30%

• Between 30 and 50%

• More than 50%

Your earnings in the future will

• far exceed inflation

• marginally ahead of inflation

• keep pace with inflation

• not keep pace with inflation

When the price of the share you have purchased drops steeply you would

• Sell your investment

• Sell part of your investment

• Do nothing

• Buy more of the same investment

There are basically three asset classes based upon the risk profiles. They are equity, debt and cash. Equity is risky, debt has low risk and cash has even lower risk. Within each asset class, the investor has to select specific instruments for investment.

Financial circumstances and the investor profile dictate the investment avenues for an investor. Financial instruments vary in terms of the liquidity, safety, and returns they offer. The challenge in making the investment decision is to choose the right combination of instruments keeping in mind the situation.

Each investment option has some advantages and some limitations. For example, while bank savings account would be highly liquid (you can withdraw whenever you like), investment in Public Provident Fund would be difficult to withdraw.

Risks are generally positively correlated with probability of returns. For example, returns in equity shares can be high, but the associated risks are also relatively higher than other options. Risks can be classified into systematic and unsystematic.

Unsystematic risks are those that can be minimised by diversifying one’s portfolio. For example, instead of investing in the shares of steel companies alone, one could invest into other sectors like pharmaceuticals and software. In this situation, your portfolio may not be terribly affected even if the steel sector were to register a mediocre performance. Systematic risks are those that cannot be minimised through portfolio diversification. For example, a Korean investor could not possibly have minimised or eliminated his loss due to currency crisis in South East Asia, through a strategy of diversification of his portfolio. The character of the investor is also important. Some Investors have the time and the knowledge to study their investment portfolios carefully – these could be called as ‘active’ investors. Others do not intend to watch their investments regularly, due to lack of time or knowledge or inclination, and are looking for essentially safer avenues for parking their funds.