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How much Risk you should Take ?

by Manish Chauhan · 17 comments

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.

Example

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

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.

Example

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.

Conclusion

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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{ 15 comments… read them below or add one }

1 Anonymous July 14, 2009 at 11:41 pm

Do you know of any calculator, where one can calculate:

(1) If amount X is invested per month for Y months and then left for Z months, what would be the value after Y+Z months?

(2) An adaptation of (1), where after a gap of Z months, one starts investing amount A for B months, what would be the final value after Y+Z+B months?

(3) Adding more complexity to (1) & (2), interest rate for different periods are different.

Apologies for not setting (asking) a trivial question (BTW, I am not in teaching profession). Thanks for your time and help.

PS: This can be one of your article for public awareness.

Reply

2 Manish Chauhan July 15, 2009 at 12:17 am

@Anonymous

I came up with some calculators earliar and also there was a post which explains formula , where you can calculate things on your own .

see

http://www.jagoinvestor.com/2008/05/calculators.html
http://www.jagoinvestor.com/2008/09/3-most-important-formulas-you-should.html
http://www.jagoinvestor.com/2009/05/video-post-on-basic-formula.html

I will give you an example .

Annuity is something which comes into picture when some fixed amount is invstested at particular interval for several times .

coumpound interest is something which comes in picture when amount is invested once and is left invested for some time frame . you can combine these two and get your answer for any scenario .

let me know if you dont understand and want more help . I will give you examples in that case . leave me a question with numbers (amount , interest rate , number of months)

Manish

Reply

3 Anonymous July 15, 2009 at 1:13 am

Thanks Manish. I would appreciate if you can verify my usage of formaula.

- For (1), use Annuity till Y months and the apply compound interest for Z months.

- For (2), use results for (1) for amount X. Apply compound interest on this amount for B months. Additionally apply annuity formula for amount A for B months.

- Use different interest rates in different formula to calculate it.

An add-on question, how can I account for SWP in any of these cases?

Reply

4 Manish Chauhan July 15, 2009 at 1:42 am

@Anonymous

Yes ,you are correct .

Regarding SWP , i did not understadn what you want ? please rephrase your qustiion.

Manish

Reply

5 Anonymous July 17, 2009 at 5:11 pm

Hi Manish,

I am new to your blog and believe me this is one of the best blogs I've ever visited.

Really very informative.

I have one request. Could you please write an article (if that is not already there and I missed it) on step by step procedure to invest in mutual funds online/offline. Because many like me want to invest in MF but don't know the detailed procedure. It would be great to see such an article.

Many of your articles describe about SIP and various MF investment and selection techniques but I was unable to find an article on the process itself.

Hoping for such an article in near future.

Regards,

SB.

Reply

6 Manish Chauhan July 17, 2009 at 9:27 pm

@SB

Thanks , I really love readers who ask :) . I am sure there can be a good article on this with procedure, but those are not too detailed , let me give you right away .

There are two ways .

- With agent : Call an agent (get number from net or website of mutual funds or just ask justdial to give you a number) . Rest all will be done by him ,Just call him and give him all the detials .

- Without Agent : Here , you will have to go to Mutual funds AMC office (not the bank) and ask them the form , Once you get it , you just fill out all the details yourself like

- Name of mutual fund
- Options (growth , dividend , Dividend reinvestment) .
- If its SIP , Tenure etc
- Nominees details etc
- Other things (pretty easy).

Thats all …

I am not sure if you were looking of this kind of details or not .

Reply back if not satisfied and I will digg out in detail and write .

Manish

Reply

7 Anonymous July 18, 2009 at 11:57 pm

Thankyou very much Manish.

That's what I was looking for and it seems really easy.

I want to digg some more options here such as online purchase/sale of MFs through NetBanking, automatic monthly payments (for SIPs) etc.

In todays Internet world everyone enjoys the convenience of sitting in front of his/her computer and watch the things happening with a click of a mouse and even better if its automatic. :)

Thanks & regards,

SB.

Reply

8 Manish Chauhan July 19, 2009 at 12:34 am

@SB

online sale/purchase of mutual fund is easy , you have a demat account like Icicidirect , and you buy or sell whatever you want, the only thing you need to see is how much brokerage they are charging for that . After SEBI abolished 2.25% as entry load , now they might be charging some percentage which you need to agree upon .

Montly payments in SIP is also something you decide in advance , when you fill in the form for mutual funds in start , you tell them is you want ECS (monthly autodebit from your account.

With advent of Internet , now life is more easy for doing transactions and we should really be using it. especially Net banking :)

Manish

Reply

9 Vishnu July 20, 2009 at 11:20 am

Hi Manish..

I came to know about your blog just 10 days ago thru Deepak Shenoy's blog. I could not resist myself from visiting your site since then.

I am a great fan of Shenoy's articles especially his investment fundas. But, these days he writes more of advanced topics in economy and market than topics in personal finance, which I am more interested in.

I am very thankful to Shenoy for referring to such a good site like this.

JagoInvestor is a complete personal finance blog and one of the top investment sites I have ever visited.

All your articles are of top quality with no doubt. Hats off. A new fan to your blog added :)

Reply

10 Manish Chauhan July 20, 2009 at 11:24 am

@Vishnu

I am glad to have you here at Jagoinvestor . We need readers like you , who are really interested in Financial planning and related stuff .

I am sure you will add great value to this blog by your valuable comments and views . Make sure you subscribe RSS feeds and other things, see top of the page .

Catch me sometime to chat personally at manish_chn (yahoo) or manish.pucsd@(gmail)

Manish

Reply

11 modeller July 23, 2009 at 6:20 pm

This is really good articles.
please check out my blog it is about Investing in Asia

http://asireport.blogspot.com/

Reply

12 sagecapital July 28, 2009 at 1:17 pm

Good article on risk. Most of us take risks that might be higher than what are required.
Risk managment is the key to long term wealth.

http://www.sagecapital.wordpress.com

Reply

13 Ajay November 14, 2009 at 8:26 am

What if I am only needing $20,000-$30,000 in investor funds? If that’s the case, can I simply setup an arrangement where they just get a 15-30% ROI say within 2 years or sooner?

Reply

14 manish November 14, 2009 at 2:54 pm

@Ajay

What is this Investor Fund ? and are they providing 15-30% return guaranteed ,thats not possible ? Find out how they are investing , where , and why ?

Manish

Reply

15 Alagappan March 26, 2012 at 7:03 pm

Manish,

I would like to know about stock market prediction is there any material or books to look upon ?

Reply

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