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  • Risk vs Uncertainty

    Article by Jayant Pai in Afternoon DC, February 27, 2017

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    Quick question: When was the last time you woke up in the morning and felt completely certain about the way your day would pan out? Sure, you may have aimed at accomplishing a series of tasks and also meticulously planned your path. Despite this, you tacitly knew and acknowledged that there was always the possibility that things may not turn out as planned. This, however, did not paralyse you and make you sit at home.

    The point I am making is that we live in an uncertain world. While some factors are within our control, there are others which are not. That is why I am puzzled to hear some market mavens advise stock market investors to desist from investing now and step in when things are certain.

    Many Indian investors appear to be taking this advice rather seriously, the current surge in the assets of equity mutual fund schemes notwithstanding. This phenomenon is not restricted to India alone. The abiding global sentiment prevailing since 2008 in many parts of the world is that stocks are 'risky' and should therefore be avoided (Despite this, stock markets have hit new highs virtually every year since then). The grief-inducing headlines in various newspapers are further cementing this belief. Everyone says that they will invest when times are 'more certain'.

    But is 'risk' always positively correlated with 'uncertainty'? The question may seem rhetorical but it is not.

    While the term 'risk' may mean different things to different investors, to an equity investor it usually refers to the possibility of capital loss. But this loss could occur at any time, not only when the times are uncertain. Besides, the definition of 'uncertainty' itself is not cast in stone. Also, the occurrence of an event will not have the same impact on all. For instance, if Greece leaves the Eurozone later this year, it may adversely impact most Greek companies but may have no impact on most Indian companies. Similarly, a petrol price hike in India may cause an uproar over here but will not incense a driver in the USA.

    Coming back to my earlier contention, it is worth pondering over the question as to when was the last time everything was 'certain'. Uncertainty has always been a part of the economic and political landscape for the past few centuries, both here and abroad. Investors who wait for the last cloud to clear will be waiting forever.

    I strongly believe that beyond a point, risk actually reduces as prices fall, even if the degree of uncertainty remains at an elevated level.

    Today, I am noticing that many investors who have missed out on the rally are waiting for a 'correction' to get in. However, often when prices do correction, those very investors will not invest, fearing a further fall.

    Waiting for that 'most' compelling price or valuation is a mug's game. It is great if you get it but it is more than likely you will not. Temporary loss is not the same as a permanent loss. Investors should fear the latter much more.

    Permanent capital loss is more likely to occur when you buy stocks when during exuberant times when everything looks rosy (For instance, purchasing infrastructure and real estate stocks in December 2007 when the whole world was convinced about those sectors) rather than buying during seemingly gloomy times. Think about it...

    The original article could be seen here.

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