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Saturday, January 23, 2016

Navigating Through Risk

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Navigating Through Risk

When people find out I work at an investment bank, they assume I am a high roller and my job involves attending a lot of fancy parties. My mum thinks all I do is dress up for office, spout jargon all day at work and come home to plan my next foreign vacation. Only an insider knows my plight and how taxing it is to have a job like this! We don't lift heavy weights like masons do, but the kind of brain-work that is extracted out of us day in and day out, is enough to tire us. This is why we need so many vacations to recharge our batteries!

Big banks deal with lots of money. But they also navigate through a lot of risk. You are probably not interested in knowing how a bank works, but will you listen if I tell you I can help you better manage your money by applying the methods of the biggies?

Banking is not all about lavish parties and disco-lights

Whether your corpus is big or small is irrelevant. You are exposed to some amount of risk even if you do not invest in the stock market. Did you know that inflation erodes your wealth over time? New York's annual inflation hovers around 6-7%, but retail inflation is much higher. Think about it. If you spent a thousand bucks on a formal shirt a couple of years back, you will be paying two thousand for something similar as of today! When you plan for your retirement, you tend to calculate most costs at present rate and save up accordingly. But if you account for inflation, the reality will hit you. Most of our grandparents are poor because they simply did not expect inflation to persist, or chose to ignore it. But you must be smarter.

Institutions have different methods of analysing capital risk. One is to classify them into credit risk, market risk, liquidity risk, funding risk, etc. On a personal level, do not dismiss this step. You might argue that you have no credit risk as you don't lend money. But think again. The money you put in your provident fund is money that the government owes you. You are exposed to sovereign risk here. If your country defaults, you will lose your money. Sovereign risk happens to be the safest among all risks, as the chances of a country defaulting is rare. But the Greek debacle will warn you that such cases are not impossible, even if rare. Countries can often print more currency to pay back its dues. But that again stokes inflation and reduces the worth of that same money.

If you have fixed deposits, recurring deposits or simply a savings balance with a bank, you are exposed to credit risk on that bank. Now, if you invest in the stock market, you are really dealing with the world of risk! Market risk becomes immediately prominent in your collection of risks. Investment banks measure their risks on a daily basis and set aside sufficient capital to tide over these risks more often than not. Take a leaf out of their book and start a contingency fund of sorts, especially if you are a high roller in volatile markets.

Risk is only something you are unaware of and do not understand. If you know it, you will do something to deal with it. Do not be scared of the financial markets. This is where a lot of money is made. Master the tricks of risk navigation instead.

This blog post is inspired by the blogging marathon hosted on IndiBlogger for the launch of the #Fantastico Zica from Tata Motors. You can apply for a test drive of the hatchback Zica today.

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