How to Thrive- Willingness to take Risk

Pearls don't lie on the seashore. If you want one, you must dive for it.

Risk and Return

Safety first is a motto that needs to be tweaked occasionally! Often we come across investors who invest all their money in Fixed Deposits stating that they do not want to take any risk.

Risk as we all know has a direct relationship to return. Simply put higher the risk higher the return. In order to ensure that our money grows we must take some risk in our portfolio.

It is critical to dive but it is important to understand how deep we are diving.

According to the risk-return trade-off, invested money can render higher profits only if it is subject to the possibility of being lost.  Figure 1 above shows the risk return comparism of various products

Risk is the amount of money you can expose to an unsafe instrument where you may lose money.  One of the main reasons that people do not take risk of investing in products other than Fixed Deposits  is that they do not understand the working of the product and they do not have the patience to hold on to an investment when it underperforms for prolonged periods.

Apart from understanding the product it is also important to understand ones own willingness to take risk.

It is important to understand what type of investor you are.

 Your investments must me made according to how much of risk you are willing to take.

Understanding your Willingness to take Risk - Risk Profiles: 

Each person has their own risk profile which is a combination of 3 components- ability to take risk which is based on your financial position, willingness to take risk is about how psychologically you are inclined to take risk (for e.g., some people find taking losses very distressing) and finally the need to take risk which is based on the investment goals.

There are 3 basic types of risk profiles where each of you may fall into –

Conservative, Balanced and Aggressive. Depending upon your risk profile, you need to allocate funds accordingly. For e.g. : a conservative investor may decide to allocate 80% into safer instruments like bonds, FDs, debt mutual funds and the balance 20% into equity mutual funds and shares. A balanced investor may decide to allocate equally between bond options and equity options. Once you know your risk profile, the percentage allocation into an investment product is based on your comfort factor. The main advantage of the risk profile is that it tells you your ability to take risk. Many people who have gone through a profile have realised that from being 100% FD investors, they can take 20-30% allocation into more risky investments.

Being moderate is important. If you choose too conservative or too aggressive investments, you risk losing the opportunity to earn a reasonable rate of return, to keep up with inflation and to meet your investment goals. The best way to plan your finances is to have specific investment goals for which you invest in a diversified portfolio according to your risk profile.

Figure 2 above demonstrates the various portfolios according to your risk profile : 

Ask your advisor today to do your risk profiling today and find out what type of investor are you.

Make sure your investments are in accordance with you risk profile.

Asset Allocation- Tool to Mitigate Risk and Increase the return on your  portfolio

Splitting  your investments across various asset classes like bonds, mutual funds, gold etc-is nothing but asset allocation. Asset allocation is the most important determinant of portfolio return and also reduces the risk of ones portfolio.

Asset Allocation encompasses the following:

• Selection of the asset classes( Fixed Deposit , Mutual Funds, Insurance , Bonds)
• Proper blending of these asset classes in a portfolio
• Managing the asset mix over time.

Refer figure 3

The asset allocation for an investor depends on the investor’s expectations of returns and the risk the investor is willing to take.

Womantra Advice    

Assess Your   Willingness to take Risk, Allocate Funds according to the Risk you want to take, and don’t forget to review it continuously. Our abilities to take risk keep changing depending on our goals.