Are you a High Risk taker? In this post we will talk about risk-taking in your Investments, be it share investing or mutual funds investing or just any kind of investing. Taking low risk can be equally disastrous as taking high risk. So in this article we will discuss how much risk you must take as an investor.
Financial Goals vs Risk you take
Firstly, we have to understand what is Risk-appetite? As retail investors we don’t understand the important issues attached with risk-taking. We blindly invest in any investment product without considering if it suits our risk- appetite or not! We have financial goals which we want to achieve in a defined time life “Buying a Rs 5 lac car in next 4 yrs” OR “Generate 20 lacs for my daughter education in next 15 yrs” and we figure out how much we should invest every month or year to meet our goals.
Depending on our Greed or Fear, we choose the products to invest in. Some choose Mutual funds, some choose Shares directly where as others may choose PPF or Bank Fixed deposits (Read how to find out Best Fixed Deposit for you). So it may happen that we may take risk which does not suit us. This risk can either be over-risk or under-risk. Both are equally bad for us. You should read How Equity and Debt provides returns.
Problem with Over-Risk
Taking Risk that is much more than we can afford or take may lead to a situation where we are unable to meet our financial objective. This is a very bad situation. We in hope of getting better than “required” returns take unnecessary risks and increase our chances to meet failure. Failure is okay but you should be ready for it. Taking higher than “required risk” can lead to this kind of situation. These issues happen because most of the times investors forget the first step of Financial Planning.
Ajay wants to generate 5 lacs in 5 yrs for his Daughter Education. He can invest around Rs 6,000 per month (See this video presentation to understand how its calculated). To meet his goal he needs to get around 12% return annually. There are different ways of achieving this like
- Investing in Balanced funds
- Combining Debt Funds and Equity Funds
- Some Direct Equity + Bank FD’s + Mutual Funds
But what if he decides to invest his money in Sectoral Funds like Real Estate or Infrastructure or invests directly in Stocks without much idea of how things work? This can either make him Much more than 5 lacs, may be 10 or 15 lacs OR it can be disastrous and he can lose his money and may not be able to generate even 3-4 lacs depending on the circumstances. Now this goal was something very important. He can not take risk for his daughter Education. If it were a car or a vacation goal, I would have said “ok – go ahead”. But Education is a Need of life. He has to understand Difference between Needs and Wants . He has to understand where to take more risk and where to take less.
Problem with Under-Risk
Just like Over-risk, taking less risk has its own issues. Most of the people who invest in Endowment Plans or Bank FD for years suffer from this virus. If you take very low risk, you may not be able to achieve your goals at the first place. Read Why Endowment plans are bad to invest in.
Robert wants to generate Rs 1 Crore for his retirement. He has 30 yrs and He can invest around Rs 2,000 for this in Mutual funds with SIP and this should be possible with Patience. He can take moderate risk but he thinks that equity markets are too risky and its something he should be away from. He is a fan for Endowment plans and traditional Bank Deposits so he invests in these two instruments. He generates Rs 15 lacs from his Fixed deposits (before tax) and Rs 13-14 Lacs from Endowments plan with his 1,000 investments in each of them.
So at the end he has total of less than 30 lacs as Retirement Corpus. He has 30% of what he needs at the end. What are the issues here? He has to Compromise with the life Style and he cant enjoy his Post-work life as he wanted because of severe financial pressure. Because of fear and reluctance of taking “required” risk he has done un-repairable damage to his financial life.
Its very important to take the investments with our risk-capacity taking high risk can lead to situation when our returns are less than expected. Because of greed we sometimes take extra risk and only concentrate on the rosy picture and forget the part which looks bad. Its an Irony but most of the people think that somehow there are less chances of bad things happening to them.
The same way, taking too low risk can lead to under performance in returns and hence after you factor in Inflation and taxes you may be in a financially fatal situation you might have lost all your life believing that you are gaining (like in the example above). Hence, you must take risk which is required for meeting your financial goals and also which you can take if things go wrong. Taking Over-risk is same as taking Low-risk. The best way to find if a Product Suits your Needs or Not is to Find the GFactor of that Financial Product.
Q. What do you think about “Required Risk” How should an investor estimate how much risk one should take?
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