Modules for Investors
More about risk and risk management
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A short primer on risk warnings and disclaimers
Considering that you’ve come to the final chapter of this module, let’s keep it light, shall we? Light, but important, no doubt. In this segment, we’re going to be taking a brief look at risk warnings and disclaimers. Since the movements in the stock market can be unpredictable, adequate warnings stating this fact are necessary. From stock brokers to mutual fund houses, every entity associated with stock market operations has now started to issue risk warnings and disclaimers to potential investors. And it is important to learn how to make sense of these terms.
What are risk warnings and disclaimers?
Remember mutual fund advertisements of the late 90s and early 2000s? Where a person reads a bunch of text at lightning speed towards the very end? When you heard it for the first time, you probably wouldn’t have understood what was being said. But after sitting through the same advertisement for the umpteenth time, you may have finally figured it out.
It goes like this -
“Mutual fund investments are subject to market risks. Please read the offer document carefully before investing.”
Now, this is the perfect example of a risk disclaimer.
What this particular disclaimer is trying to say is that since mutual funds invest in the stock market, they are subject to all of the risks associated with the stock market. And that it could even lead to losses in the event of adverse market movements. It also asks you to read through the mutual fund offer document before you decide to invest your money in a scheme, so you’re well aware of and understand the risks involved in such investments.
Like this, you can find many other risk warnings and disclaimers out there. Some very vague, some very detailed, some very explicit, and some in the fine print right at the bottom of the document or the screen.
Why are they even issued in the first place?
Risk warnings and disclaimers are essentially issued by stock brokers and by institutions running investment schemes to enlighten investors of the potential risks involved in that particular mode of investment. As a matter of fact, the Securities and Exchange Board of India (SEBI) has even enacted several rules that require entities connected with the stock market to disclose any and all risks associated with investing in the stock market. This was done as a means to protect investors. That said, that’s not the only reason why these warnings and risk disclaimers were issued.
Another probably an even more important reason stock brokers, mutual fund houses, investment firms, and financial institutions widely issue these warnings is to protect themselves from lawsuits. Why would they have to protect themselves from lawsuits, you ask?
Assume that you see an advertisement for a new mutual fund offer. Since this is an advertisement, the fund house spares no expense to make the scheme look attractive to potential investors. Now, assume that in the advertisement and offer document, the scheme runner has only talked about the positive aspects of the scheme. They have not made any risk warnings or disclaimers of any sort.
After taking a good look at all of this, you go ahead and invest your hard earned money into the scheme, trusting the scheme runner. However, the market moves against your favour and you end up losing a significant chunk of your investment. You later find out that all the investments in the stock market are prone to this risk.
And had you known about this at the time of investment, you would have probably taken a more conservative approach or even stayed away from investing altogether. You feel disappointed and cheated. Now, in this case, say you try to seek legal help for breach of trust and for claiming damages. And if every single investor of the scheme files a lawsuit along these lines, imagine the plight of the scheme runner.
It is for this precise reason that stock brokers and mutual fund houses tend to disclose risks through warnings and disclaimers. By notifying investors of the potential downside risks and pitfalls, they can protect themselves from lawsuits.
Where can you find these warnings and disclaimers?
Stockbrokers generally tend to put up risk warnings and disclaimers on their website. In addition to that you can also find them on the agreement that you sign with your broker as part of the account creation process.
As for mutual fund houses and other financial institutions dealing in the stock market, you can see risk warnings and risk disclaimers on their website and on the offer document of the mutual fund. That said, not all warnings and disclaimers tend to be explicit or extensive. Sometimes, they can be listed vaguely as a footnote or as part of the document’s fine print. So, when looking for them, always make sure that you scour through the entire document.
Risk warnings and disclaimers: An example
Here’s an example of a disclaimer that Angel Broking displays on the homepage of the company website.
Although the disclaimer is short and contained within a single sentence, it clearly specifies that investing in the securities market (which includes stock, commodity, and currency markets) carries risks.
Here’s another example.
This is the table of contents page of a new fund offer (NFO) document from Aditya Birla. The risk factors associated with investing in the mutual fund have been elaborated just after the highlights of the scheme. And if you read through the document, you can clearly see that the scheme runner has dedicated almost 4 pages just for risk warnings and disclaimers alone.
Such an extensive disclosure not only helps the scheme runner comply with the SEBI’s rules and regulations, but also protects them from lawsuits in the event of lacklustre market performance.
What should you, as an investor, do?
Now that you know what risk warnings and disclaimers are and why they’re issued, let’s take a look at what investors like you should do with them.
First and foremost, when you encounter a risk warning or a disclaimer, always ensure that you don’t skip that part. Read through it thoroughly instead. Even if the warnings or disclosures are not very evident or easy to spot on the first glance, make sure that you sift through the entire document till you find them. Many investors either actively choose to not look at risks, or are ignorant about them. Either way, investing in a scheme without actually being aware of the risks can only cause harm.
2. Try to understand the warnings
While reading is important, understanding what you’ve read is also equally crucial. Not all risk warnings and disclosures tend to be explicit or in a language that’s easy to understand. Some can even be vague or confusing. Therefore, it is extremely important to devote some time and effort to understand the warnings properly before investing in a scheme.
3. Seek professional advice
If, at any point in time, you find yourself having trouble trying to understand these warnings and disclaimers, never hesitate to seek professional advice. You could directly reach out to the scheme runner for clarifications on the risk disclosures. They would be in a much better position to answer any and all queries or doubts that you may have. Alternatively, you could reach out to an investment advisor for help too.
4. Always err on the side of caution
Now, risk warnings and disclaimers generally are broad statements that don’t quantify the risk, since the performance is solely dependent on market movements. So, what you can do is err on the side of caution and assume that your whole investment is under risk, irrespective of the past performance or assurances given by the scheme runner. This way, you can stay prepared for any adverse eventualities well in advance.
And that’s a wrap on this module. The chapters in this module would have likely helped you understand risk and its importance. In the next module, we’ll be moving on to the debt market and the various instruments that you get to trade. It’s going to get even more exciting! So, stay tuned.
A quick recap
- You can find many other risk warnings and disclaimers out there. Some very vague, some very detailed, some very explicit, and some in the fine print right at the bottom of the document or the screen.
- Risk warnings and disclaimers are essentially issued by stock brokers and by institutions running investment schemes to enlighten investors of the potential risks involved in that particular mode of investment.
- The Securities and Exchange Board of India (SEBI) has even enacted several rules that require entities connected with the stock market to disclose any and all risks associated with investing in the stock market.
- Another important reason stock brokers, mutual fund houses, investment firms, and financial institutions widely issue these warnings is to protect themselves from lawsuits.
- Stockbrokers generally tend to put up risk warnings and disclaimers on their website.
- In addition to that you can also find them on the agreement that you sign with your broker as part of the account creation process.
- As an investor, you should read and understand these warnings and disclaimers before investing.
- Seek professional advice if you cannot understand some of these statements.
- And always make sure you invest cautiously.