Check your risk profile before you start investing
Do you know that you cannot blindly invest without knowing how much risk you can take?
So, you are gung-ho about embarking on an investment strategy. You have decided that you will save money henceforth and invest it smartly to make it grow. You have consulted with your friends and family, have a fair idea on what all options that you plan to take. Great show! While you are all set and raring to go, may we say slow down please? Do you know what your risk profile is? Do you know that you cannot blindly invest without knowing how much risk you can take? Good, now that we have caught your attention, read on for these quick checks.
# 1 Loans and Liabilities: The first and foremost facet to be considered before you embark on investing is to take stock of your loans and liabilities. Loans are simple. You have a track of them, even if you do not realise it! Generally, the EMI payment is deducted from your bank account. Just make a note of them.
Next, let us understand what we mean by your liabilities. Liability is defined as legally being responsible for something or a thing whose presence puts one at a disadvantage. Here we are purely talking in the financial sense. Any expense or responsibility which requires your contribution monetarily becomes a liability. Of course, loans are an example of a liability. Apart from loans, this includes your monthly expenditure towards the upkeep of your family, school fees, compulsory medical bills to be footed and are not covered by insurance, and any other similar mandatory outflow of cash from your end. Make a note of these as well.
# 2 Age: Obviously, the younger you are, the higher risk you can take (it includes those who are young at heart as well!). By age, what we are trying to say is, that when the age is lower, the investments have a longer time to reap rewards. Also, there is more time to pivot and make amends for any bad investment made. So, age does become a factor. One easy rule to follow is using 100 – your age to calculate the equity exposure of your investments and this can keep going down, as you become older provided your loans and liabilities are under control.
# 3 Income: Your income and its steadiness is another major factor which contributes to your risk profile. Are you in a good job which pays you enough to cover all your essential needs with ease? In case a couple of investments take a longer time to reap returns, will your day-today living take a hit? Do you have adequate money to cover your back in case of any contingency? A yes to all these questions will push your risk capability to a higher level. Even a single no, will bring it down by a few notches.
# 4 Investment Time Frame and Investing Mindset: It is believed that the time mitigates the risk of any investment. The riskiest of investments become profitable when one stays invested for a longer time. So, if you are looking at a shorter horizon of investing, say 0-3 years, then obviously, your risk appetite will be lower. The longer one is willing to stay invested, the higher the risks that they can afford to take! On one hand, the time frame for investing is important, while on the other the investment mindset of an individual is also of significance. In case, you are willing to stay invested for long but your aim is to protect your capital then automatically, your risk-taking ability is lower.
Answer the following three questions to know your investment mindset.
Imagine that you have invested in the stock market. If the market suddenly starts going down and is touted to crash, will you stay invested or will you salvage whatever is left of your investment?
In a scenario where you have Rs.300,000 to be invested for a period of 4 years. Will you choose an option which can give 30% returns but carries above average risk or will you choose an option which gives 12% returns with low risk?
The reason you are investing is: to multiply your money x times its value or gain more money but with minimal risks?
If you have chosen the first option for all the three questions, you have a pretty aggressive mindset as an investor. In case you have chosen the second option for all the three questions, you are more of a risk-averse investor. If you have chosen a mix of both the options, you have a moderately aggressive mind-set in case you chose more number of first options, and a mildly-risk averse investor if you have chosen more of the second options.
Summing up, most investors fit into the following risk profiles. Which one is yours?
The writer is founder of Right Horizons