Good investing often means going against your instincts as well as conventional wisdom. Risk and retirement are topics where both will mislead you.
Here's something Warren Buffett once said, "Those who're looking for risk-free returns are more likely to find returns-free risk." Unlike much of what the grand-old man of investing says, I actually disagree with this. Or rather, I disagree with the implicit meaning of risk in this statement. Conventional measures of risk take it to mean volatility over a standard period. This is wrong. Instead, risk actually means the probability of not achieving your investment goal over a given period of time.
Here's an example that will show you what I mean. Suppose you invest for 10 years. The real risk is the probability that you will not achieve your goal at the end of ten years. The fake measure of risk that the investment industry promotes is based on measuring the annual standard deviation of your investment for each of the ten years. In everyday language, if your investment goes up in a zigzag fashion for those ten years, (and occasionally falls too), then it's supposed to be risky. However, the reality is that if the overall gains are good, then that zigzag does not matter.
So how does this fake idea of risk connect to your retirement. It is a deep belief amongst Indian savers, investors and investment advisors that retirement savings should be invested with the lowest risk possible. This may be a fine idea but in practice, the impact of this obsession with zero risk is terrible because it ignores the risk posed by the biggest threat to your financial well being, which is inflation. Sorry to put it so bluntly, but if you ignore the effects of inflation in your retirement savings, then you are heading for old-age poverty.
Take the example of the decade gone by. A typical fixed-income option would have yielded a return of a little more than 8 per cent. An investment of Rs 10,000 a month would have grown to about Rs 18-19 lakh. Over the same period, an average (far from the best) equity fund would have grown to Rs 25 lakh, a return of about 14 per cent. Extend this kind of differential over three decades and the equity option would have generated about 2.5 to three times what the fixed-income option would have generated. This kind of difference between returns would make the difference between a saver starting retired life in prosperity versus always struggling to make ends meet.
Actually, the time horizon of retirement savings is even longer than we generally suppose. People take the date of retirement as the target date of the investment. Retirement may be an event in your life, but from a savings-and-investment perspective, it is not an event but the beginning of a long stretch of retired life. At the age of 55, you may think that retirement is just a decade away so your retirement kitty should be in 'non-risky' investments but actually that doesn't make any sense. You will be using the earnings from your investments when you are 65, 75, 85 or 95 years old. In those 30 or 35 years, prices would again multiply five to seven times, maybe more.
Clearly, the conventional ideas of risk and retirement are perfectly described by the term 'return-free risk' that I began with. Savers who want to successfully provide for their old age must think through these issues clearly and abandon the trap that conventional thinking leads them into.
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