Case Study 2 When risk isn't bad?

The title of this case study might take most by surprise. After all, we have been conditioned to believe that while investing, risk is bad. Well, that's not entirely correct. Taking on risk without understanding its implications isn't right. Similarly, a common mistake made is that risk is considered in isolation. The right approach for evaluating risk is to consider it in conjunction with return what is commonly referred to as the risk! return trade!off. Another vital aspect about risk is being aware of one's risk appetite and sticking to it at all times i.e. being unambiguously sure of how much risk one can take on and not e"ceeding the same. #ften age is used as a reference point to evaluate one's risk appetite i.e. the older an individual gets, lower is his ability to take on risk. This case study deals with a client of $utura %onsulting , &s. 'ibha (hare who re)uired assistance in financial planning. Facts of the case &s (hare was a **!+r old single lady i.e. she had no dependents. She was a salaried individual earning ,s -.,... per month /pm0. The %onsultants at $utura %onsulting started off with a series of discussions with &s. (hare to better understand her risk appetite and the reasons for the 'e)uity!free' portfolio. They begun by asking her one simple )uestion ! 1f she was investing in the stock markets for the long!term, and the stock markets were to fall *...2 the ne"t day, would she panic3 4er answer was an emphatic 56o5. The reason &s (hare had steered clear of e)uity7mutual fund investments was because she didn't )uite understand what they were and how they functioned. #n the other hand, investments in fi"ed deposits and small savings schemes were something she was conversant with and had traditionally invested in. 4ence, she chose to stick to the same time!tested investment avenues. .

The following table gives &s. (hare8s 1nvestment allocation in %ase 9 and $utura %onsulting8s recommendation in %ase *. Expected Case Case 2 Rate of Wei#hted !sset Wei#hted Return !sset !""ocation Return !""ocation Return 9...2 9;..2 =..2 >...2 ;..2 *;..2 >..2 ..?2 9.?2 >...2 ;...2 9...2 >..2 =.;2 ..=2

Investment

,eal estate <)uities @ebt Aovt. debt B gold

;..2

-...2

*..2

9...2

..;2

6ow let's get back to &s. (hare's case and her second problem area of not setting investment objectives. The %onsultants reali:ed that &s. (hare's investment activity was carried out in an 5off the cuff5 manner. She wasn't aware of the importance of setting objectives before commencing any investment activity. As a result, she was yet to decide on any concrete investment objectives. 1t transpired that &s. (hare planned to get married in about ; years. So there was an investment objective that merited immediate attention ! accumulating monies for the wedding. As per &s. (hare's estimate, she would need /at present cost levels0 a corpus of ,s ;..,... to meet the wedding e"penses. Assumed return is 9;2. <"pected inflation is =2

$uestions 9. As the %$# of $utura %onsulting what are your #bservations after reading the %ase3 *. What Ccategory of ,iskD does &s. (hare fall into3 >. 1s the advise given by your %ompany8s %onsultants correct in the light of the above observations 3/Substantiate your answer by giving the ,isk and ,eturn for the portfolios given in %ase9 and %ase *0