Risk & Return

Investment, which at times can produce extremely good results, can at other times produce extremely poor results. Responsible investment advisers and financial planners spend much of their time in evaluating the risk element associated with a  particular investment. However, the question of risk is often not discussed or is quickly brushed aside in investment publications by most of the promoters of certain financial products. Often investors are persuaded to make an investment because they are told that it does not face the risks associated with other investments. 

Another very important factor to consider is the risk of not being in the market. This may be termed Opportunity cost. By investing in one asset class that achieves poor returns you have passed up the opportunity of investing in another asset class that achieves very good returns. This is one of the major reasons for constructing diversified portfolios. Over the long term, not having some investments in the higher performing assets can significantly affect the investor's wealth creation, as the effect of compounding at a lower rate results in a lower total portfolio value. 

Market timing is also important when considering risk. What is the best time to buy or sell? Generally assets such as quality shares and property show sound, consistent performance over long periods of time. However, if investors expect strong growth in a short period then they may be disappointed. Where the client has available funds, the best strategy is probably to just purchase the appropriate investments. If the client does not have a sizeable amount of free cash, they can begin a savings program. Benefit of using a savings program is that over a period of time the volatility of prices will mean that the client will have purchased their portfolio at average prices (Rupee cost averaging). 

Risk

Risk may be defined as the deviation of actual return from expected return. Risk is a measure of uncertainty that is the basic reason that one investment will pay a greater return than another. In a business, a greater return may arise from one factor or a combination of factors such as good management, sensible borrowing, and careful assessment of market and economic conditions. Economic conditions, including supply and demand, affect return and increases or decreases in return of various markets. For instance, interest rate variations affect return. 

There are two types of risk:

a. The first is where there is some probability of a negative outcome that will have financial implications, This is usually a risk to property or person and can be covered to some extent by insurance. 

b. The second type of financial risk is associated with investment. This is where there is a risk of flat, low, no returns or a loss of capital. 

Return

Investment is a current commitment of rupees for a time period to derive benefits in future. The future benefits derived from investment are know as returns. There are many factors that determine the level of the returns. The investors who sacrifice their current income would like to get compensated for 

⦁ Loss of liquidity for the time period of sacrifice

⦁ the expected rate of inflation;

⦁ the uncertainty associated with the investment. 

Investment involves the purchase of financial assets that are expected to produce a return or series of returns over time. In the broader economic sense, funds invested in securities (a term encompassing shares, debentures, bonds and other financial instruments) are redeployed and put to productive use by issuer of these securities. 

Return on investment is likely to be investor's main concern. Return may be in the form of income alone or a combination of income and capital growth gain (increase in value). Investment may also be structured in such a way as to produce returns for the investors in the form of capital growth alone.  

Income returns are dividends in case of shares, rent in case of property, and interest in the case of loan debt securities such as bonds. Property and shares may increase (or decrease) in value over time, but the capital value of a loan will remain unchanged if there is no movement in the general level of interest rates. Bonds too can appreciation in value on account of general interest rate declines.

The choice of an investment instrument for an individual will depend on his or her need for capital growth and income. 

Value Averaging Investment Plan (VAIP)

Value averaging is a technique of adding to an investment portfolio to provide greater return than similar methods such as dollar cost averaging and random investment. It was developed by former Harvard University professor Michael E. Edleson.

Value averaging is a formula based investment technique whereas mathematical formula is used to guide the investment of money into a portfolio over time. With the method, investors contribute to their portfolios in such a way that the portfolio balance increases by a set amount, regardless of market fluctuations. 

As a result, in periods of market declines, the investors contributes more, while in periods of market climbs, the investor contributes less. In contract of dollar cost average which mandates that a fixed amount of money be invested at each period, the value averaging formula to identify periods of investment over-performance and under-performance vs. expectations. 

After the investment has over performed, the investor will be required to buy less or sell. After the investment has underperformed, the investor will be required to buy more (buying low).  Some research suggests that the method results in higher returns at a similar risks, especially for high market variability and long time horizons. 

The first step of any investment program is always the hardest, and individual investors taking their first steps in an investment program must also confront a sea of stock market uncertainty. Some plunge headlong into the market with all their savings. Others barely wet their feet before heading back to the safe shores of their fixed income deposits and money mutual funds. The problem with these two approaches is one of timing - the risk of entering the market is at a high point in the market cycle.