The Risk of Investing in Investment Products You Need to Know

“Risk comes from not knowing what you are doing.” Warren Buffet

Investment is a risky affair. Since it is about your money, this risk is important to understand.

Here we present in brief the risk associated with different financial investment products.

The Safest Investments in India:

Government bonds, Public Provident Funds, all investment schemes of the Post Office are the safest investments. Return offered is risk-free so less as compared to other relatively risky instruments. But if your risk appetite is zero, you should only invest in these instruments.

Fixed Deposits – Banks:

Usually nationalised banks’ fixed deposits are safe. There is deposit insurance and every deposit of Rs.1 lakh is insured by every bank. This insurance is applicable to Govt, private, cooperative and foreign banks.

The limit of Rs. 1 lakh is per bank. This means risk insurance of deposit in different branches of the same bank remains at Rs. 1 lakh. However, deposits in different banks are each covered for Rs 1 lakh deposit insurance.

Nationalised banks are safe. If you are concerned about your deposit in other banks, split it into Rs 1 lakh each in different banks.

Fixed deposits Companies:

By its very nature company, fixed deposits are an unsecured investment. If the company fails, fixed deposit holders are paid after every secured creditor is paid.

For the sake of higher interest do not invest in the fixed deposit of weak companies.

Mutual Funds:

There are various types of mutual fund schemes.

These are:

  • Money Market: Invests in Govt bonds, treasury bills etc. This is usually a safe investment.
  • Fixed Return: Investment is usually made in Govt bonds, corporate bonds etc fixed return instruments. This is usually a safe investment.
  • Equity: The money is invested in the equity shares. Though the funds are managed by a professional fund manager, equity by its very nature is a risky investment.
  • Balanced: Under this fund, the money is invested in the equity as well as fixed income bonds. This way fund managers try to manage risk and return.
  • Index Funds: Here money is invested in select indexes like BSE 100, NIFTY, etc. These indexes are traded like a stock in the market. Investment is made in the scripts of the index in the same proportion. Usually, these funds give the market rate of return. These are safer as the risk is evenly divided among many stocks. However, equity market risk remains.
  • Specialty Funds: These are funds like real estate funds, retail funds, health care funds, banks funds etc. They invest in the companies of industry or category. These funds enjoy and suffer forms sector specific reward and risk.

Equity Shares:

The return on equity shares is subject to the performance of the company. To that extent, it’s a risky investment.

It has the potential to give the highest return on investments. Some of the wealth creators’ companies have made many investors millionaires. However higher the potential of return higher is the risk.

Invest your risk capital in select blue-chip companies. But know the risk of investing in companies without a solid track record.

“You have to understand accounting and you have to understand the nuances of accounting. It’s the language of business and it’s an imperfect language, but unless you are willing to put in the effort to learn accounting – how to read and interpret financial statements – you really shouldn’t select stocks yourself” Warren Buffett

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Debentures:

These are issued by companies. It could be either secured or unsecured. This is a kind of loan at a fixed rate of return given by investors to the company. It has a fixed rate of interest, fixed period of maturity.

It could be either convertible or non-convertible. Convertible debentures are converted to equity at a pre-determined price/date. Non-convertible debentures are redeemed at a given date after a period.

If it is secured it’s secured against the dedicated assets of the company. If the maturity is longer than 18 months, companies have to appoint debentures trustee to manage the assets apportioned as a security for the investors.

This trustee manages the assets and takes care of the interest of the investors.

To this extent secured debentures are safe. However, if the performance of the company or any such incidence which brings down the value of the security, the risk is open to that extent.

However, in the case of bankruptcy, since debentures (both secured and unsecured) investors are creditors, they have a right to their money before the money is paid to the equity shareholders.

MLM Investment Schemes/ Ponzi Schemes:

Multi-level marketing (MLM) schemes are allowed in India if it is for the sale of products/services. This is kind of direct selling network.

However, there were many under the garb of MLM selling their Ponzi schemes.  A Ponzi Scheme is a fraudulent investment scheme. It is a kind of MLM fraud which promises a high rate of return to its investors. The returns are paid to the old investors by employing the cash inflow of the new investors. Thus, the scheme relies on a constant flow of new investments and falls apart when the flow of investors stops.

This is a huge risk investment. It’s avoidable. Equity investments are also huge risk investments, but that risk is subject to business risk whereas Ponzi schemes risk is subject to fraud risk.

Avoid any investments which offer more than a reasonable market rate of return.

Chit Funds:

This is usually managed by a group of people informally. A few people come together and collect money. They lend among the group members.

Usually unregistered and managed by a group of people. It can offer more than bank rate of interest, but the risk is high as the industry is not regulated by SEBI or other such Govt institutions.

These are private banking transactions of saving and lending.  High-risk investments.

Life Insurance Policies:

Life insurance companies in India are regulated by IRDA. IRDA prescribed stringent rules for the company to enter the insurance business in India. These companies are monitored closely by the regulating agency.

Secondly, it is mandatory for every insurance company to maintain solvency margin with it. This is 150% of the insured amount. This ensures safety.

Thirdly, no insurance company can wind up at their own will.  They must merge with another company to protect the investors’ money and policies.

This way life insurance money is safe. However, if you have invested in ULIP kind of market-linked policies, then your fund is subject to market risk as it is applicable in the case of mutual funds.  However, these funds are managed by experienced fund managers. To that extent, the risk is managed better as compared to pure equity investments.

Handpicked related post: Do you know how you are mismanaging your money?

This is at a glance view of investment products in India and risk associated with each one of them.  Now you can decide how to allocate your investable capital. Know the kind of risks you want to take and the kind of risks you want to avoid.

Do it carefully and do it smartly.

“An investment in knowledge pays the best interest.”  Benjamin Franklin

You may also like to read: 9 Key Financial Literacy Aspects You need to Know

 

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