Reasonable and unreasonable risks in investing and money management

These are some reasonable and unreasonable risks in investing and money management.  We all agree that some risk is necessary for our careers, life, and investing. But not all risks are the same.

Some risks have a reasonable chance (not a probability) of success based on common sense and/or history if given enough time and other safety measures are in place. For other risks, the data (history) tells you that most people fail. So, it is a no-brainer that we choose reasonable risks and avoid unreasonable risks. Let us make a list.

Unreasonable risks

1 Futures & Options:  A SEBI research paper published in Jan 2023 states, “89% of the individual traders (i.e. 9 out of 10 individual traders) in equity F&O segment
incurred losses during FY22, up from 87% in FY19. The percentage went up to 90%
for active traders and further to 94% on excluding the outliers from active individual
traders’ group (active trimmed) during FY22”.

“For the group of active traders, on average, loss makers registered net trading loss close to ₹ 50,000 in FY22. For the group of active traders (excluding outliers), the average loss of a loss maker was over 15 times the average profit by a profit maker during FY22.”

2 Intraday Trading: A SEBI research paper published in July 2024 states “During FY23, 7 out of 10 individuals (71%) trading in intraday cash segment were loss-makers”.

“Higher the turnover, higher the proportion of loss-makers – Across the three years
under the study, it is observed that the proportion of loss-makers was higher in
turnover groups with higher turnover, with the ‘Very Small’ turnover group being an
the exception to this trend, recording a significantly higher proportion of loss-makers.
During FY23, the ‘Very Small’ turnover group had the highest proportion (77%) of lossmakers compared to other turnover groups.”

“Lower the age group, higher the proportion of loss-makers – Proportion of loss-makers was lower among traders under higher age group. In FY23, traders under
the age group of more than 60 years had the lowest loss-makers (53%), while those
under 20 years of age had the highest proportion of loss-makers (81%).”

“Even after three years of experience (individual traders who traded intraday during
FY19, FY22 and FY23), 54% of traders were loss-makers in FY23, but this reflected
a much lower percentage than overall loss-makers (71%) in FY23.”

3 Derivatives: A SEBI research paper published in Sep 2024 states, “Almost half (42 lakh traders) of all the F&O traders were “New Traders” in FY24. 92.1% of these “New Traders” experienced net losses and on average incurred a net loss of ~
₹46,000 per person in FY24”.

“Almost 25% of all the traders were “Regular Traders”. 88.7% of these “Regular Traders” experienced losses and on average incurred a net loss of ~ ₹1,50,000 per person in FY24”.

“In FY24, 91.1% of individuals made net losses (i.e. trading losses inclusive of transaction
costs) in F&O, compared to 91.5% in FY23 and 90.2% in FY22. In terms of gross P&L
(i.e. trading profits & losses before accounting for transaction costs), 85.1% of
individuals made losses in FY24”.

“91.1% of Individual F&O traders (about 73 lakh traders) incurred losses in F&O in
FY24. These loss-makers incurred an average loss of ₹ 1.20 lakh per person (lower than
₹ 1.43 lakh per person in FY23)”.

4 Crypto Trading/Investing: I believe that lossmakers here would be no different than the ones mentioned in the previous categories. Plus, other risks like scams, security, etc. make them unreasonable.

5 Real Estate Investing (not consumption): There is no hard data to back this. So it is an opinion. As an investment, RE is quite opaque. There is no fair market price—the price changes from house to house in the same locality. The deal has no transparency, with the buyer/seller insisting on black money agreements.

There is no guarantee that the property will appreciate higher than FD or equity returns over time. There are too many unknowns at play, making this an unreasonable risk for me,

6 Fixed-income investing: Many investors consider tax-free fixed-income options like PPF, SSY or taxable but high-interest rate Fixed Deposits.  Too much of fixed income in a portfolio will guarantee erosion in value due to inflation, making it an unreasonable risk.

Chasing after high interest rate fixed income products has concentration risks, making it unreasonable.

Reasonable risks

1 Long term equity investing: Analysing the S&P 500 returns, we have shown that the chances of equity return beating inflation are better than a coin toss – Why should I invest in equity mutual funds when there is no guarantee of returns?

This makes the investment reasonable. But since it is it not a guarantee, investors should not invest too much in equity. About 50-60% is enough for goals over ten years away.

More importantly, long-term investors must have a solid systematic risk management plan by gradually de-risking their equity exposure. Our research, which was explained in the goal-based portfolio management course and incorporated into the freefincal robo advisor, shows that this has more than a reasonable chance of success regardless of market conditions. This is also explained here: do not expect returns from mutual fund SIPs! Do this instead!

2 A small exposure to gold, preferably via a multi-asset fund, is a reasonable risk and can lower portfolio volatility for those who know how to measure.

3 The same reasoning also applies to international equity. A small exposure, preferably via a diversified (Indian) equity-oriented fund, is a reasonable risk and can lower portfolio volatility for those who know how to measure.

That is as far as my thinking takes me. Please let us know if you have something to add to these lists.