I was brainstorming this article with a lady and we were talking about Warren Buffet’s statement that one should invest 90% of one’s corpus in equity.
To my exclamation that Buffet makes sense, she rejoined saying “I don’t have so much risk appetite!” I couldn’t help but smile at her statement, though it is a statement I have often heard (usually in a very righteous tone!). Do you know what is risk?
Let us take the example of a typical life insurance product, which is often touted as the one-stop-solution to all confusions by an insurance company. I have three shots against this kind of investing, though it looks safe, it is expensive, gives you low returns and makes you lose money.
It says if I were to invest ₹5 lakh today for a period of 10 years, I will get an insurance cover of ₹6.5 lakh. That is if I were to die anytime in the next 10 years my family will receive Rs 6.5 lakh from the insurance company.
If you buy a simple insurance policy that doesn’t have any fancy features but just insurance cover, which means if I die during the term my family gets money; I don’t die the policy lapses. This is called term insurance. A term insurance policy by the same insurance company for a sum of ₹1 crore for a period of 30 years comes for ₹2.13 lakh — 15 times the cover, 3 times a longer period and at a premium which is 37% less.
Shot One: It is expensive.
After 10 years you will get back ₹9.5 lakh, that is a return of ₹4.5 lakh. They say it is 9% for every year you stay with them. Is there a catch here? Yes, big time!
They mean 9% of ₹5 lakh that is 45,000 multiplied by 10 years; simple interest. Whereas the biggest benefit to any investor comes from compounding, where interest earned in year 1 gets added to the original principal and hence in year 2 you get interest on the principal along with the interest earned in year 1. The same principal that makes you scream while repaying loans works in your favour, as here you are the investor.
So practically speaking, this ₹9.5 lakh is equivalent to a bank deposit that gives you an interest of 6.6% per annum.
Shot Two: It gives you low returns.
In the 10 years that you will wait for your money to come back, the world around you and prices in it will not stand still. Prices will rise. We can safely assume it will go up by 7% per annum over a period of 10 years. So whatever you could buy for ₹5 lakh today will require ₹Rs 9.84 lakh after 10 years. Sadly, the payback for your insurance company won’t be of much help then.
Shot Three: It makes you lose money.
Risk isn’t just about losing your money visibly. The bigger risk is that of losing purchasing power. Imagine yourself 10 years later when you have a shortfall in the amount you saved for a goal, would you call your investment decision wise.
Learn to read financial data, get an unbiased expert opinion, even pay for it if needed. Don’t just buy what looks good. Risk isn’t in instruments, risk is lack of knowledge.
Play safe, Play it with knowledge…..Happy Investing!
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