At an event recently, N R Narayana Murthy, the founder of technology services giant Infosys Technologies, said that it is not prudent for businesses to look at initial public offerings or IPOs as a financing round.
A lot of companies go public, creating high expectations before delivering profits. That is because they overestimate the market size for their products or services. Investors read about the company’s market assessment in the draft red herring prospectus, if at all. You would find the company management crowing about prospects in a positive light. A lot of new investors buy into that only to suffer a loss.
Companies like Zomato and One97 Communications, the parent of Paytm, the payment service, are prime examples. Other new-age technology companies too make no profit but hope to have a sky-high market value. Modern-day technology companies should take a leaf out of how Murthy and his founding team took their company public. Managing a business is a lot about managing the expectations of stakeholders.
These include shareholders, bondholders, employees and society. You cannot be on a path of losses and expect investors to support your business. Similarly, you cannot default on loan payments and be a successful bond issuer. You need to do good to employees and society and maintain a credible financial performance.
As an investor, you may wonder about your ability to judge all of that in a business. You are just a minority investor, and it is very little you can do about upholding ‘prudence’ in the company you invest in. However, when investing, you can avoid being reckless. That can be prudence to some extent. Managing risk is a skill that you need to hone to manage your finances.
Risk diversification
You want to create wealth to ensure the financial security of you and your family. If you are responsible for managing the money in your house, you have a responsibility.
You are also dealing with the expectations of family members. Your children may be in school for now, but they would want to pursue a professional career. As a parent, you would like to support their endeavour. You could be living in a big metropolitan city but aspire to move to a bigger living space than now. You need your money to work for you.
The only way you can create wealth for yourselves, in the long run, is by investing in equity assets. They are your only chance to beat inflation over the next 10 to 15 years. Diversification of risk is possible through a portfolio of assets. If you are already into finance, you are aware of asset allocation. You probably may also have a financial advisor for support. They would advise you to spread your risk by putting money across asset classes. When investing in equity, you got an option of buying shares directly or investing through mutual funds or index funds.
If you are new to investing, you must know that taking risks is needed for creating long-term wealth. At the same time, you do not have to research or indulge in stock picking. Investing in gossip is the last thing you need.
The simplest way for you to take risks but diversify simultaneously is to invest through equity mutual funds or index funds. There is no shortcut to wealth. You have to set aside your investible surplus and stay invested regularly.
When to take the risk
Your risk appetite is based on your ability to generate income. If you are confident about that and have a steady income, there is no reason why you cannot invest regularly and create wealth. Prudence suggests avoiding risks when you have income uncertainty. Your priority should be to protect yourself and your loved ones from any financial risk. Building an emergency fund is more than just prudence.
The pandemic of 2020-21 and subsequent lockdowns have proved that an emergency fund should exist in your bank account and be much more than previously thought. Saving money at every step is prudence. Investing is a risk, but it is prudence when done with the proper asset allocation.
When to be Prudent
Your risk appetite is based on your ability to generate income. If you are confident about that and have a steady income, there is no reason why you cannot invest regularly and create wealth. Prudence suggests avoiding risks when you have income uncertainty. Your priority should be to protect yourself and your loved ones from any financial risk. Building an emergency fund is more than just prudence.
(The author is editor-in-chief at www.simplusinfo.com)