The need for capital protection in Investing

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That there is no return without risk is not mere financial theory, but an investing reality

 

There is an old story about Mulla and his friend. The friend hides his bag of gold coins in a small pit in the garden. Every other day, he digs it up and counts the coins. One day, he runs back to Mulla to report that the bag has been stolen. Mulla tells him in his character istic style, "How does it matter? You weren't using the money anyway." Many of us like to treat our money the way Mulla's friend did. As long as it is there we are happy, even if it is lying unutilised and idle. Our obsession with the protec tion of our capital is harmful for wealth

The returns from investing can come only when the money is made to work When we use the money, we spend it when we let someone else use our mon ey, we invest it. It would be easy for all of us if investment choices were simple straightforward, and came with that one factor that pleases us—no damage to the invested capital. Many investors confi dently declare that they are not asking for too much when they insist on one basic criterion—that they get back their invested money. It is not possible to put the money to use and protect it as well and if we place it in a bag in our backyard like Mulla's friend, it will lose

Anyone who uses our money will build assets with it. The return from these assets will be used to provide us the return on our invested capital. Any asset-building activity is fraught with risk. If the finance textbook tells us that there is no return without risk, it is not mere theory, but a simple statement of investing reality. Anybody who uses our money, including the bank, is using it to build assets, and this activity cannot be done without taking risks.

The student who went to an engineering college and found that the promised job was not there at the end of the course, has also made an investment and is faced with the risk of low returns. The travellers who took the delayed aircraft, tourists who ate a less-than-satisfactory meal, and the people who found that they married the wrong person have all taken risky decisions. There is no rule book that would have helped them make better choices with predictable outcomes.

If we take risks easily when it comes to several critical decisions in our lives, why do we seek the unattainable capital protection in investments?

 

Behavioural have out that we are not too capable of making com plex decisions that involve a lot of vari ables. We simply use rules of thumb that make it easy for us. If the food smells good, we are willing to eat it without stepping into the restaurant's kitchen.

When it comes to finance, we run back to capital protection because the thumb rules we frame in our mind are broken too often and the promise of per formance is too far away in the future How financial assets will perform in the future is an unknown variable both com mon investors and experts grapple with all the time. Even the best-laid plans can fail; the best-managed businesses can collapse; and well-thought out strategies can misfire. When there is a deep fear of the unknown, we choose to clutch on to capital protection. It is our search for simple and easy-to-understand outcome that encourages us to seek capital protection from our investments. Next in line is the fixed rate of return. We term both these needs as 'minimum' displaying our need for anything that we can hold on to, given the complexities in the world of finance.

We are very prone to making errors when we operate from this eager position of seeking unrealistic simplification. We buy into tall claims easily. Someone who prints a brochure listing 'assured' returns is able to mobilise money and run Ponzi schemes. Investors trust these claims even more when the capital is returned as promised. The return of capital, complete and intact, is the sign of a good investment in our minds, when we have shut out all complexity. Fraud sters, therefore, play on this need. We also trust 'experts'. We think that some one else could have figured the complex world of finance, and if they also have track record of success, we can follow blindly. This fits in with our need for simple rules and visible performance.

Soon enough, we have exposed our selves as eager believers of stories that hold these ingredients. The thumb rules spread far and wide. 'You won't lose money in an IPO.' 'You should sell when a fund manager changes.' 'You should buy on a Monday.' 'You should buy before the budget.' None of these rules work consistently.

What is worse is that the unscrupu lous world of finance smiles on benevo lently when we are ripped off our wealth with false promises and premises. From trading portals that encourage specula tion, to distributors who tell us that our money will earn 15%, we, as investors have been exposed to organised lying and cheating. We make money for a short duration and then spend a longer period in complete remorse, having lost even more. We return to our comfort zone where we seek minimum criteria to in vest. It all sounds reasonable to ask for 'at least' capital protection after having lost a fortune with risky investments.

We would be open to understanding risks in investing if we are able to sift out the risk that is avoidable. In a world where we are not shocked by rampant unscrupulousness and fraud, where we are confident about the disclosures made to us, we are able to trust those who ask for our money, we may be ready to learn about risks. Until then, with each shock that we suffer, we will run back to the need for capital protection, however unrealistic

 

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