Identification Of Risk & Risk Management

The Kapoors are young architects who have been saving for various goals for the past few years. However, they have ended up parking all their money in bank deposits because they could not decide how much of risk they were willing to take in their investments. 

While the idea of losing money makes them uncomfortable, they know that they will have to take some risk to generate better returns. They want to know if transferring some money to an investment with high return potential will help them meet their financial goals quickly. They are not sure if there is a simple way to identify the risk they can take in their investments. 

The Kapoors’ willingness to take some risks will help them identify investment instruments suitable for their goals and plans. The first thing they need to do is to segregate their goals clearly as each will need investments with different risk, return and liquidity features. Segregating the goals according to the time left to achieve them way is a good way to start. Some of their goals may be short-term, such as a holiday. Other goals such as plans to accumulate funds for the down payment of a home have a medium time frame while retirement goals are typically long-term. 

Setting a time frame for goals will help them decide how much investment risk they can take for better returns. This is because some investments may give high returns but the returns may be volatile over the short term. Such investments require a sufficiently long investment time frame in which the volatility will smoothen out. The Kapoors may be tempted to assign high return investments for their shorter-term goals if they have fallen behind in terms of the goal amount. But the risk in doing that is they may find that the value of the investments has dropped when they need the money. 

While selecting investments based on the time horizon of their goals, the Kapoors must remember that a longer investment horizon alone does not make a fundamentally bad investment less risky. They must invest only in sound instruments after evaluating their strengths and features. By aligning their investments to the goal horizon, they will make sure that the level of risk is appropriate without being too high. They can put their savings at risk to earn good returns without putting their goals at risk from inadequate funds.