Risk is real while risk management is a vague term. The uncertainty of the future events generally eats the return on investment. Understanding the risk and uncertainty is the only solution.
Risk is a term which we often use in daily life. We encounter some amount of risk while driving, cooking, or even dining at a new restaurant. In general terms, risk means the possibility of something undesirable happening. Let’s say you choose a newly opened restaurant for dinner on your marriage anniversary. Selecting a newly opened restaurant for dinner on such an occasion could be risky because of the absence of any history (Food Quality, Service, or Ambiance.) of the restaurant. Anything undesirable could spoil your evening. So the risk is real, and it persists every time you make a decision.
Now to mitigate such a risk, you choose a popular and highly rated restaurant for the evening. While you and your better half were dining in the restaurant, a waiter accidentally poured a cup of soup on your clothes, or to make the matter worse, poured soup on your wife’s dress. Now, this incident could potentially spoil your evening in the same way as the tasteless food or bad service by a newly opened restaurant.
The above example was to demonstrate that inherited risk in the decision-making process, no matter how small it is. According to Investopedia, “Risk is defined in financial terms as the chance that an outcome or investment’s actual gains will differ from an expected outcome or return. Risk includes the possibility of losing some or all of the original investment.” Most of us make the financial decision based on the advice of financial dailies or financial advisors or friends with some interest in investment. While making a financial-decision, we all more or less are aware of the risk involved.
The critical part of the risk assessment process is the basis on which risk has computed. The risk assessment has been done based on past experiences. An event that never happened in the past does not consider while assessing the risk. The outbreak of the COVID-19 pandemic is one such event. Past events like Tsunami and the Global Economic meltdown of 2008 destroyed many investors across the world. The primary reason for the global economic crisis of 2008 was the undue risk taken by the investment and risk managers. Several complex risk debt securities (Synthetic CDOs) were invented by the investment managers to mitigate the risk, which created the collapse of banks like Lehmann Brothers.
The investment in risky and complicated securities had been criticized world over by many institutes, post-2008 Economic crisis. According to some research agencies, these complex securities are now again attracting investments. Investment and risk managers assured that they possess the necessary skills, due to the experience gained during the 2008 economic crisis, to deal with such kinds of complex securities. It is correct that now they have a better understanding though they are still ignorant about the unpredictability of the events, which could create another crisis.
All the investment instruments currently available in the financial market contain the disclosure of the risk exposure, and most of the investment managers use this disclosure to sell the financial products as a transparent product. The risk disclosure only discloses risk but not the type of risk. The performance of the financial market depends upon many variables. The return from the financial market cannot be ascertained or assured, due to the uncertainty of the variables attached to it.
The insurance of a company or a product makes it safe for investment. During the 2008 financial crisis, highly valued insurance and re-insurance companies were involved in the insuring risky assets and companies which led to their debacle as soon as companies with risky investment started to collapse. If an insurance company can commit a mistake with all the available tools for assessment, then surely we can underestimate the risk and uncertainty.
Most of the investment managers and companies sell financial products by underplaying their risk.
The post-2008 financial crisis, all the investment instruments such as mutual funds, etc. had directed by the government across the world to disclose their risk status. All the corporations were instructed to reflect their liability and assets transparently in account statements and many laws were passed in the parliaments to protect small investors. But still, most of the corporations do not disclose all the information nor investment manager sticks to the guidelines issued by the authorities.
The investor should understand that even in the so-called safest investment carry some amount of risk. There is no investment without risk. One cannot predict the return on investment until it knows the future. It means none can predict the correct return on investment. Past returns cannot be used as the indicator of future returns because the events in the future could be different from past events.
While investing investors must ask relevant questions and understand the risk appetite properly. Do not get allured by the claims of high returns and always keep in mind that the only certain thing is uncertainty. While investing avoid complicated instruments and try to understand all the aspect of investment product. Lastly, knowingly or unknowingly Risk managers do not eliminate risk , they only hide them.