‘Risk comes from not knowing what you’re doing’ – Warren Buffet
As human beings, avoiding uncertainties comes naturally to us. We are governed by the need for certain outcomes in almost all aspects of our life & investing is no different. As far as possible, many investors try & avoid taking risks while choosing their investments thereby, completely avoiding equities in their portfolio! But they don’t understand that not taking a certain level of risk is a risk in itself.
There is an old saying – “A ship in the harbor is safe, but that is not what ships are built for”. When we think of a ship associated with the word ‘risk’, it is likely that we are reminded of the Titanic and its sinking (the worst-case scenario). The same extends to equities. The moment equities are mentioned, some investors picture the worst-case scenarios like the DotCom (2000), Lehman brother (2008) or the COVID crash (2020). Therefore, most investors in India tend to play safe and keep money in savings accounts or fixed deposits. What they fail to realize is that markets not only fully recovered but bounced back very strongly after all crashes. So, instead of taking such crashes as a threat, shouldn’t we take them as an opportunity and invest more for the long term (a topic for another article).
But if the money is kept idle, inflation will erode its purchasing power over the years.
The greatest long-term risk is not ‘loss of principal‘ but ‘erosion of purchasing power’ and inflation tends to erode the purchasing power of money over time. In other words, there is a heavy price to be paid for clinging to certainty. To understand it more deeply, we need to understand the table below:
As evident from the table above, FDs and savings account provides the comfort of knowing the end value but this comfort comes with a heavy invisible price tag – the erosion of investment value to inflation. Therefore, it can be concluded that equities are key ingredients of wealth creation in the long term as they generate returns superior to the rate of inflation.
To sum it up, there is a risk of ‘erosion of purchasing power’ in completely avoiding risks of ‘equities’.
