You actually don’t need to learn risk and return if you are an Indian, because it is built into our culture.
One reason why IAS type jobs are so very revered by all Indian parents is because they’re so very risk averse. And when I say “they” I mean both Indian parents and IAS type jobs. The biggest draw of being an IAS office is that “naukri pakki hai“. Sure, being an IAS officer will mean that you can’t become the next Zuckerberg, but again, “naukri pakki hai“.
That’s our cultural fascination with the whole engineer/doctor trope too – these used to be educational options that would guarantee you jobs. It didn’t matter if you wanted to do these jobs or not – that wasn’t the point. What mattered is that you stood a fairly decent chance of getting jobs if you had an engineering/medical degree. I should know – I am an engineering dropout.
Given what our economy went through in the 70’s, 80’s and at least the early 90’s, it is an entirely understandable societal response. Screw everything else, land up a job first.
The point I am trying to make is that we, as a nation, were risk-averse. The returns from doing something that you wanted to, whether psychic or financial, weren’t the point. It was about minimizing risk. For all I know, most of us still are risk-averse. The MBA degree isn’t about being an entrepreneur, it is in fact the exact opposite – it is about landing a job.
This risk-aversion spills over into other areas of life as well. Fixed deposits over mutual funds, mutual funds over stocks, and gold and land above all else are also about risk-aversion. Mind you, there is nothing wrong about being risk-averse. Or right, for that matter. At the end of the day, your risk appetite is a function of a whole variety of things, not all of which can (or should) be viewed from the lens of economic theory.
But the one thing that economic theory (well, finance, really) can tell you is the following. If you want risk aversion, you can’t get high returns at the same time. High returns come with high risk, and that’s just the way it is.
This takes us back to our discussion on hedging:
A hedger is somebody who ain’t worried about missing out on a high-paying job later. A hedger prizes certainty. A hedger mitigates risk. The price you pay for mitigating risk – the opportunity cost of risk mitigation – is that you lose the potential upside.
https://atomic-temporary-112243906.wpcomstaging.com/2021/02/01/so-what-are-forward-markets-what-is-speculation/
Read the whole post if you haven’t already, but the basic point is that the opportunity cost of safety is low returns. And it cuts both ways: the opportunity cost of aiming for high returns is high risk. A batsman aiming to hit a six is an example of high risk, high returns, and a batsman aiming to defend well is an example of low risk, low returns.
Now, you’ll often hear finance folks talk about barbell portfolios:
Taleb presents the barbell strategy as a bimodal attitude of exposing oneself to extreme outcomes: one extremely risk averse and another very risk loving, while ignoring the middle. The objective of the strategy is to limit downside and to get exposure to extreme upside outcomes. The possible outcomes are more certain, and the risk of exposure to “black swan” events is much smaller.
https://www.gurufocus.com/news/804852/nassim-talebs-portfolio-approach-the-barbell-strategy#
But rather than think about it in terms of financial theory, think about it in terms of MS Dhoni’s innings. He’d perfected the portfolio of shots he’d play in his limited overs innings, and it was a pretty good barbell portfolio. Extremely risk averse at the beginning, and god didn’t we all love the fireworks at the end?
The point is, don’t expect to get high returns when you’re minimizing risk, and vice-versa. But also, don’t try to have the same attitude (completely risk-averse, or completely risk-loving) for every single asset in your portfolio. Minimize risks with most, and go all out on the ones that remain. Nassim Nicholas Taleb and MS Dhoni are telling you the same thing.
And of course, as a student, you should always be asking yourself, where else is this applicable?
EconForEverybody 