Authored by: Malay Chitalia
Inspiration: Resp. R. Gopinath
In order to achieve something worthwhile, we need to take certain risks in our life. Taking risk is inevitable. Not taking Risk at all is the biggest Risk a man takes in his life. The question is when should we take Risk & when we should not.
There are some Golden rules of Risk Management which guides us how to choose our Risks wisely:
Let us understand this systematically:
1. Taking Risk for Self is allowed; Taking Risk for Family is not allowed:
I happen to work with many Businessmen. Taking Risk is in the DNA of a Businessman. Generally, Businessmen have a great fighting spirit. They must have fallen so many times & they would have got up every time. They know instinctively & intelligently how to deal with these risks. Almost all of them, have become successful after taking a good amount of Risk in their Business. However, there must be a Firewall between Business Risks & the Risks which are associated with Family. Sometimes they become so irrational that knowingly or unknowingly they pass-on this Risk & Liability to their family members as well. Some Businessmen get a thrill of undertaking those Risks. The reward associated with the Risk also allures them. However, family does not require that thrill, instead family needs the Peace of Mind.
When a Businessman gets a big order, he tend to take a huge loans & don’t hesitate to mortgage even his home, jewels & other personal assets. That’s how he passes-on this risk to his family members also. And imagine, if he does not survive to repay these loans, what will happen? It will create a disaster for the family. Our family members, our children are so innocent, they are unfit & unaware about how to deal with the cruel customs of this world.
If an individual or a businessman taking a Risk on himself, on his personal pleasures & luxuries, its allowed. However, taking Risk for his family is not allowed. Whenever a person decides to undertake some Risk; he must observe whether the impact of this Risk will be limited to himself or will it get extended to his family also! Same thing is applicable while doing Financial Planning, investing & buying insurance. When a person buys financial assets & insurance, he must ask himself few questions; Is he buying Risky assets? Will the Risk impact his Family? Who are going to use these assets? Will the family members be able to claim those assets in his absence without any hassles?
2. Taking Risk on Present is allowed; Taking Risk on Future is not allowed:
The sound physical & mental health we enjoy today, may not be there in future. The situation which seems favorable today, may not be so favorable tomorrow. We may have a fighting spirit & fighting energy today, we may not have that same spirit & energy tomorrow. There can be accidental disabilities & deformities which can victimize the man. There are number of Critical illnesses like Cancer, Paralysis, Heart Attack, Brain Stroke which can suck the life out of man.
Whatever risk we want to take, we can take it on our “Present”, but we are not allowed to take risk on our “Future”.
Generally, we buy assets for the future use. We must take a due care while buying the set of assets. Am I buying a Risky asset? Will I be able to handle that asset in future when I will grow old? Relations & family equation changes with time; will these assets be useful considering the risks associated with the asset?
3. Taking Risk for Non-Essentials is allowed; Taking Risk for Essentials is not allowed:
When we are planning for some financial goal, which is non-essential in nature like buying a luxurious car or buying jewelry or having an extravagant holiday, we are allowed to take Risk for achieving those goals by taking a route of Equities, Mutual Funds or other risky products.
However, when we are planning for some Essential Goals like Education Planning for Children, Retirement Planning, Securing financial well being for Spouse, Planning for Settling-down capital for Children etc. which requires non-negotiable amounts, we are not allowed to take Risk.
4. Taking Risk on Returns are allowed; Taking Risk on Capital is not allowed:
I started my career in the traditional small markets of Mumbai. Even today, I have many clients who belongs to such markets. They make a huge turnover on daily basis by operating from a very small spaces of 10’ x 10’ or even lesser. Traders who have an excess capital, they lend these moneys to the other small traders who are in need of money. In return, the lender earn a whopping rate of interest which starts from 12% p.a. upto 18% or even more. At the same time, I often come across the news of borrowers getting bankrupt and sinking whole capital of the lenders.
Losing the capital, in order to earn a high interest; is it a wise decision ? This is greediness.
Let us discuss one more chemistry of Risk & Reward.
Mutual Funds are good instruments to invest into. They offer many benefits to investors and one of them is, it helps beat the inflation. If an investor is investing some portion of his income into Mutual Funds rationally, it brings wealth to him.
However, let me evaluate Mutual Fund investment from a technical aspect.
In our country, there are some good instruments which provides RISK FREE RETURNS upto 7.50% p.a. For example, some of the LIC plans offer such RISK FREE RETURNS with the Sovereign Guarantee from Govt. of India for the capital plus accumulated bonus.
We all know that Mutual Fund provides average annual growth somewhere between 8% to 15% annually, provided you stay invested for a long term. If your Mutual Fund portfolio has yielded between 12% to 15%, its worth taking that Risk by investing into Mutual Funds because you have gained approx. 5% to 8% over & above RISK FREE RETURNS. However, if your portfolio ends up yielding total CAGR 10% or lower, it’s a bad deal. Because, just to earn 2.5 Rupees more, you took the Risk of your 100 Rupees (capital).
You must choose your Risks wisely.
Buying a Term Insurance – Risk Vs. Reward:
There are many Life Insurance Companies offering Term Insurance at Rs.400/- per month. Many cheaper Term Insurance are being sold by Web Aggregators. Is there a sense buying such cheaper insurance ?
Mind well, there is a difference between Cheap & Economy !
Let us take an example. Term Insurance for Rs.1 Crore available at the cost price of Rs.30,000 (approx.) from a good company. So annual cost is 0.30% of Sum Assured.
The other company is offering Term Insurance for Rs.1 Crore at the cost of Rs.10,000 (approx.). Annual cost comes 0.10% of Sum Assured.
To save the cost of just 20 paisa p.a., you are taking the Risk of Rs.100/-. Is it a wise decision ?
Now please take a look at the Golden rules of Risk Management Table once again which we discussed in the beginning.
Taking Risk for Self is allowed; Taking Risk for Family is not allowed: By buying a cheaper Term Insurance, the Policy Holder HIMSELF enjoyed the discount of 20,000 p.a. However, he passed on the Risk of Rs.1,00,00,000 to his FAMILY which is not allowed.
Taking Risk on Present is allowed; Taking Risk on Future is not allowed: By buying a cheaper Term Insurance, Policy Holder passed on the Risk to Future which is not allowed. Actually he should have taken the Risk of paying the more premium IN PRESENT to avoid the unfavorable consequences in FUTURE.
Taking Risk for Non-Essentials is allowed; Taking Risk for Essentials is not allowed: Paying a more premium of Rs.20,000/- p.a. is a negligible expense & its non-essential item as Policy Holder exists in present time with his ongoing income. However, after the demise of the Policy Holder and no Family Income, the claim amount of Rs.1 Crore could have been an Essential amount which could have taken care of family’s basic needs.
Taking Risk on Returns are allowed; Taking Risk on Capital is not allowed: After the demise of Policy Holder, the claim amount becomes the Capital for the family which has lost its Bread-winner. Those 1 Crore rupees can make a huge difference in the Life of the family members. By buying a cheaper Term Insurance, he took the Risk on capital to save mere 20 paisa extra cost.
Conclusion:
Life is full of Snakes & Ladders. In order to achieve great heights, we need Ladders; but be aware, huge Snakes are also present in the game, they may compel you to start the game of Life from the scrap. Till the time it compels only YOU, it does not matter, but when it compels your Family members to start the game from Scrap, this is the big reason for worry !
How would it be if you get only Ladders in your life, and no snakes ! There are some time proven & scientific methods of Financial Planning & Risk Management which presents you only Ladders in your life and no snakes. Consult your professional Financial Advisor who can guide you & lead you to the path of the Great Game where there are only Ladders; no snakes !
Happy Investing !
