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The Risk in Risk-free Investment

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What is a risk?
For most, it’s a possibility of losing the subject, be it money or the ship.
It has been proven in most of the experiments that severe pain of loss is much bigger than the extreme joy of making profits. So the common man looks for avenues, which is safe for him and the probability of losing the principal in the said avenue is minimal. So, according to nature, an investment avenue which is relatively safe and provide guaranteed returns over the principal with the safety of the principal is said to be a risk-free investment.Most of the risk and return metrics are also based on risk-free investment returns. So if an investor wishes to explore the risky investment for the higher return, he will be expecting risk premium. He should get a return over and above the risk-free investment in terms to nullify the risk he is taking to put his principal money in danger. Till now there are more talks about the risk premium and risky investment avenues, it is very little said about the risk involved in the risk-free investment. Let’s explore this area…
What could be the risk involved in risk-free returns and how you can tackle it?
First of all, risk-free return is not stagnant, this will be the market risk in risk-free investment. The interest rates on such risk-free investment will be influenced by key economic rates decided by the central bank of any country. The central bank takes this decision mostly to control the cash and inflation in the market. So the return on such investment will be volatile over a course of period, as the economy grows stronger the rates will see more of the downwards pattern.
Consequently, the second risk will be the inflation. Supposedly, if you are keeping most of your money is such risk-free investment, the effective return on your entire portfolio will be facing the risk of the negative real rate of return if we take inflation into account. The diversification will help to minimize this risk. A prudent investor will seek a healthy return over and above the inflation rate at a given time horizon, so the effective return of the entire portfolio will matter rather than of a single product. If you are investing 50:50 in equity and debt (risk-free) and equity is giving you 12% and debt is giving you 6 then the effective return will be 8% only, if you are taking 8% inflation, perhaps you will be on par. So construct your portfolio to make good use of diversification and to arrive on the % stake of different investment avenue for your good.
The third risk will be the liquidity. This will be the major criteria for many people, this should be but sadly people do not take this risk into the account. There are few risk-free investment options available which are highly illiquid and people lock their money just for the sake of good looking and tax-free returns. With the considerable amount of volatility in the market and foreign influence which affects domestic markets over a short term, it will not be wise to lock in your principal for a long time horizon.
Therefore, the conclusion of this post is, you should look beyond the risk-free investment now and you must be as the interest rates are reducing every year. Being a wise investor, you should be able to capitalize the benefit of risk-free investment until and unless it’s in your favor, furthermore do venture out in other investment avenues as well.

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