Before you can actually invest responsibly, it is crucial to take a long look at your risk tolerance. Risk tolerance is simply not your capacity for bearing losses, or volatility in investment return.
Before you can actually invest responsibly, it is crucial to take a long look at your risk tolerance. Risk tolerance is simply not your capacity for bearing losses, or volatility in investment return. All of us invest with a goal in mind, and risk is when that goal is not reached in due time. For instance, for a father saving money for his daughter’s marriage, the real risk is not being able to marry her off at the right time.
Likewise, “for a working mom who is investing money for son’s education, the real risk is not being to arrange finance when he has got admission in a good college. For all of us who are keeping money for retirement, risk means not having adequate money for retirement. Risk tolerance depends on a variety of factors, including your age, time for reaching goal, your personality, and why you’re investing,” says Anil Rego, Founder and CEO of Right Horizons.
Your age is the single most-important factor in finding out your risk tolerance. Younger people, who have decades of earning life at their disposal, can afford to take on more risk in the pursuit of long-term gains. However, those who are at the end of their career, cannot take even small amounts of risk. The earlier you save and invest, the more risk you can take. With each year of delay, your risk appetite will go down, but you would be forced to take more risk to achieve results in a shorter time.
Time given to investment
Investors who will need their money for retirement can’t afford to withstand more risk. Anybody who has less than 3 years to give for his investment goal, should not invest in assets like equities. “Different investors have different needs and time-horizon. For less than 3 months to 12 months, you should only keep funds in liquid funds and bank FDs. With more time, you can afford to take more risk. For those with 3 to 5 years time, definitely go for equity-linkeed investment,” says Rego.
When people go for vacations, all of us want to have fun. For some, the definition of fun is outdoor sports. For quite a few others, fun means bungee-jumping, paragliding and motorcycle trekking. Some people are natural risk takers, and their personality allows them to accept more risks for investment portfolios than an ordinary person. If you think your personality is of a high risk-taker, ask yourself this question: How comfortable are you about investing money in something where gains and losses can be huge?
For somebody aiming to get to a corpus of Rs 1 lakh in a year by saving Rs 8,000 a month, no investment is probably required. He/she can just save Rs 8,000 in a bank account to get to that corpus. However, “for somebody who wants to get to Rs 20 lakh in 10 years, investments are definitely required in a regular fashion. If they just save Rs 10,000 per month for 10 years, ie 120 months, they will arrive at Rs 12-13 lakh only. To get the additional Rs 7-8 lakh, they need to invest the entire amount in an asset that will give them 10% return every year,” says Rego.
Have you ever bought clothes for yourself by using the size of your best friend? Most likely the answer is no. “There’s, thus, no ‘one size fits all’ approach when it comes to investments as well. To know how much risk should you take on, find out the risk level by using your age, your goal, your personality and time for investment,” advises Rego.
Choose your investments accordingly thereafter!