Is equity investment risky

An Excellent article on equity risk on Moneycontrol.com

http://www.moneycontrol.com/india/news/mf-experts/is-equity-investing-really-risky/16/59/327825


Many a times when individuals say that they want to refrain from investing in equity because it is risky, it seems little amusing. These are the same individuals who ride two wheelers without a helmet or drive a car without the seat belts. What is more risky - investing into equity or riding a two-wheeler without a helmet?

Firstly it is important to note that all forms of investment have inherent risk. The reason we get returns on our investment is because we take the risk of parting with our money. There are some risks, which are transparent while there are few which we do not see.

Equity investing seems risky because the risk is transparent. Investor in equity can see the gain and/or loss made by them based on movement of stock price on the stock exchange. If an investor had purchased stock of Tata Steel at Rs 568 and if the price falls to Rs 523, he/she can see and calculate the loss. This is unlike an investor of fixed deposit who does not see his gain in interest and also does not see the loss he has suffered due to rise in inflation. Simply because fixed deposits are not traded on any exchange and its price movement is not transparent, they seem to feel safer.

Another reason people find equity investing risky is because returns from equity are not linear. Suppose we have invested in bonds yielding 8% p.a., our bonds would generate a fixed 8% returns year on year. In case of equity, it does not work like that. Here, the returns could be 40%, 33%, -3%, 17%, -10% and 2% year on year. Since the returns are not linear it is difficult to predict them and because it is difficult to predict, we find equity investing risky.

Usually we are fairly certain about events that are likely to take place in our lives in near term. We know what we will be doing in next one minute, one hour, one day etc. We also have a good estimate of our activity schedule for the next week or so. However as time horizon increases, our certainty about events in our life decreases e.g. most likely we do not know what will happen in our life after one year. In business it is reverse. Ask a corporate how much goods they will sell in next one minute and they are clueless. Give them an hour and still the same reply. They even cannot guess their daily sales. However ask them to guesstimate their yearly turnover and they would be able to predict almost accurately. As human beings we seek near term certainty. Since that is difficult to come by in equity investing, we find it difficult to absorb the reverse behavior.

Each asset class has different behavioral pattern of return and risk. There isn’t anything like risk-free investing. Just because in equity measurement of risk is transparent, returns are not linear, and it is difficult to predict in short run, it should not be construed as risky.

Lastly, there is a famous line, which says ‘Rome was not built in a day.’ It takes years to build a business. Sometimes, even after the business is built and settled, it can face turbulence. Unfortunately we are not willing to wait for long to earn our returns. In many cases people are not even willing to wait for 2/3 years to get returns. Here I would like to quote legendary investor Warren Buffet who once said “If you aren’t willing to own a share for ten years, then don’t own it for ten minutes.”

If your financial goal is more than 7/9 years away always give consideration to equity as well.