Investment and Risk

How to maximize your returns on the investments:

The objective in personal finance is to maximize the risk adjusted return on capital employed.

It involves 2 basic principles which are as below:

1. A safe dollar is better than a risky dollar.

2 A dollar in hand is better than a dollar receivable in future.

This lets the investors look at safety and time value of money.

Having said this, one should invest in order to make the most of the money. If one does not take risk, what one gets as return is the return that is not adjusted for risk, and is generally equal to the sovereign risk, which in today’s US environment, is the T bill rate.

The excess return that is expected in an investment over and above the risk free rate is called risk premium.

In this case, the risk free rate is the rate of return that is expected in a no risk environment, say investment in T bill.

One can maximize the return by investing the money, which could take the shape of equities, bonds, ETF’s , commodities or real assets. The risk premium in each of the asset classes is different since the risks involved are different.

Looking at various asset classes:

Equities – Investment in equities is considered to be one of the well known investments. If one anticipates the economy to grow, equities as an asset class grow the fastest. This is by far, the most known investment style. This may further take the form of value strategy or growth strategy.

On can reduce the risk in equity investment by focusing on ETF ( Exchange Traded Funds) or Index funds.

Bonds:- The other safer form of investment is investment in fixed income securities like bonds. The risk that one takes in such investment is that one is assuming that the corporate will be able to fulfill his promised obligation of coupon payments.

These are often called as Debt securities, where the company/corporate has raised debt for either the company’s operation or expansion and in turn, has a contractual obligation to pay it back as per the pre-agreed terms.

The coupon is the interest that the corporate pays, and maturity date is the date on which the corporate will return back the debt in the pre-agreed form.

If we have done a careful research on the strength and cash flows of the corporate company, this can be a very good investment strategy.

Alternative Investments: While stocks and bonds are conventional investments, there are lot of alternative investment strategies. Most popular amongst them are Hedge Funds, that invest in various strategies, whether macro, arbitrage, relative value or any other strategy. They generally are analysed by the alpha generated ( the return in excess of the benchmark return), the volatility and ratio’s such as sharpe ratio and sortino ratio.

Commodities: Another nice way of investment is investments in commodities including gold and other precious metals.

Since prices of commodities generally are a good indicator of inflation, commodity investments can be a good hedge to inflation.

Real Assets:

Other forms of investment are investing in real assets. These can be investments in Timberland, Real Estate and other real assets.

The advantage with investment in real assets is that one gets regular income apart from capital appreciation.

Asset allocation strategy:

What is essential in the investment world is to plan and allocate your capital across different asset classes in order to reduce the risk and enhance the return.

A safe way to start is to invest some portion of the assets in index linked funds, while today’s recessionary markets show favouritism to corporate bonds/fixed income securities.

Ensure that you plan your asset allocation strategy through a professional advisor prior to jumping into investing.

A portfolio which is balanced across the asset classes as above, and is in line with your own investment objectives will generate returns which match your returns by taking care of the 2 primary principles as mentioned initially:

The concept of safety – A safe dollar is worth more than a risky dollar.

Time value of money: – A dollar worth today is not the same as a dollar one year down the lane.

Wish all the investors a successful allocation plan and investment success.