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Risks in Banana-Split Ice Cream

Author: Venkata Ravi Ram/Wednesday, August 29, 2018/Categories: Financial Planning, Expert View

Risks in Banana-Split Ice Cream

A few days back, in an indulgent mood, I ordered a banana-split. This is supposed to have a well…a split-banana with three flavors of ice-cream between. This shop-guy decided to dice, instead. I told him it was supposed to be banana-‘split’ not, diced. He pointed out the three flavors, so did it matter whether the banana was split or, diced. It did for me. Having to divert my mind lest I vent-off, I looked at the three flavours and thought about the other risks that mattered in financial life apart from this risk of living in a small place. Here goes.

All investments come with three associated risks — Market-risk, inflation-risk and psychological risk. All known investments have one or more of these flavors of risk. While the degree may vary, any one or, as in most cases a combination, is always present. Let’s look at each flavour. 

Market-risk is the most visible risk. You see investment adverts daily on TV, mobile screens or, newspapers (they still exist!) with small-type warnings regarding market risk etc. Stock market risk is seen everywhere with markets making highs/lows etc. Not so obvious swings are in equity mutual NAVs that swing equally, as ultimately underneath the NAV it is the value of shares change. In case of debt funds the debt value changes daily with time and interest rates. Even those ‘safest’ government bank deposits carry risk because theoretically the government too can default or, at least postpone the payment till they print more notes (which they can and do!).

Less visible but a little more dangerous is the inflation-risk. This creeps in slowly in all investments and erodes value. Akin to depreciation in the value of your bike/car, the value of the rupee too erodes with time as inflation bites-in. Remember the snacks you used to buy at school? Compare the price of the same that you buy for kiddos. The government publishes inflation rates regularly. Keep track of inflation, it is important to decide the mix of investments.

Our third flavor of risk, psychological risk is the most dangerous, as it involves - you! Various errors of judgement like familiarity-bias, anchoring-bias cloud judgement of even the most seasoned investors. Exceedingly difficult to overcome but, being aware of this biggest risk is a good start. 

The aim of your investing philosophy must be to mitigate these three risks. Market risk is generally reduced with diversification of investments across asset-classes like equity, bonds/deposits, real-estate, gold, cash etc. Among those asset-classes, equity exposure has been the most proven method to beat inflation-risk. The psychological-risk of the individual-biases can be overcome using process-based methods like auto-debit, SIP, standing instructions. These remove the need for the person to take a call whether to invest that day or, not. With the three-flavours of risks controlled, you can better enjoy the fruits of the investment or, simply a banana-split!     

The author writes commentaries on contemporary financial, business, taxation and political issues.

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Venkata Ravi Ram
Venkata  Ravi Ram

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