Why you should choose investments that contain downside risk while participating in upside?
When markets are in bull phase, most investors ask for the best performing stock or the best performing mutual fund scheme. If a scheme has given 100% returns in past year, it is the best bet for them. But in reality one should look at the ability to contain downside as much as the ability to generate returns in the upside.
The old adage says that today's investor does not benefit from yesterday's returns. If an investment has shown good appreciation in the past, that does not make it necessary that it will keep giving similar returns in future. Hence there is no point focusing too much on returns generated by an investment. An investment that has done well in the past, may actually post a loss in future. For example, an individual who invested in January 2008 in equities looking at spectacular returns posted in CY2007, have lost money in CY2008.
Downside cannot be ruled out altogether in financial market, and especially in volatile asset classes such as equity one has to be very careful. Consider this - a stock has fallen to Rs 40 from purchase price of Rs 100. In this case the investor is sitting on a loss of Rs 60 or 60%. Now if he wants to recover the loss, his investment must show a gain of 150% and not 60%. An investment that contains downside helps the investors in bad times. Aforesaid example makes it clear that the required rate of return to recoup losses is higher than the rate of loss. Do look for investments that offer high returns, but do not ignore how they are expected to behave in bad times.
When markets are in bull phase, most investors ask for the best performing stock or the best performing mutual fund scheme. If a scheme has given 100% returns in past year, it is the best bet for them. But in reality one should look at the ability to contain downside as much as the ability to generate returns in the upside.
The old adage says that today's investor does not benefit from yesterday's returns. If an investment has shown good appreciation in the past, that does not make it necessary that it will keep giving similar returns in future. Hence there is no point focusing too much on returns generated by an investment. An investment that has done well in the past, may actually post a loss in future. For example, an individual who invested in January 2008 in equities looking at spectacular returns posted in CY2007, have lost money in CY2008.
Downside cannot be ruled out altogether in financial market, and especially in volatile asset classes such as equity one has to be very careful. Consider this - a stock has fallen to Rs 40 from purchase price of Rs 100. In this case the investor is sitting on a loss of Rs 60 or 60%. Now if he wants to recover the loss, his investment must show a gain of 150% and not 60%. An investment that contains downside helps the investors in bad times. Aforesaid example makes it clear that the required rate of return to recoup losses is higher than the rate of loss. Do look for investments that offer high returns, but do not ignore how they are expected to behave in bad times.
Happy Investing
Source:Moneycontrol.com
No comments:
Post a Comment