‘Mutual Funds take a long time to give returns. Stocks are risky. Bank Deposits are safe. Do not indulge in high risk investments!’ We keep on hearing these statements lot of time, isn’t it?
But before you blindly trust these statements, let us understand the relationship between risk & returns.
Risk is never a one-sided situation. When you avoid one risk, you are accepting another. Generally, the higher the potential return of an investment, higher is the risk! Though, there is no guarantee that you will actually get a higher return by accepting more risk. The trade-off between risk and return is a key element of effective financial decision making.
Generally, the negative news & risks are exaggerated & over emphasized. This thing drives less informed investors away from the potential opportunities in favor of the investments that can give higher returns over long time.
It is perfectly normal for any individual to avoid risks. Any sane and responsible person who has worked hard for his money should avoid the risk of losing his hard earned money. But that is just one side, the investor who respects his capital, should also fear the monster like inflation. So which risks do you fear most? The risk that we did not anticipate or think about, is always the one that causes the most damage!
Well, do you know what is your Risk Profile or risk taking ability…???
Answer these questions…
- How much risk are you able to handle?
- How much risk are you willing to handle?
Your ability to handle risk is your ability to handle an investment loss. For instance, a young investor with no liabilities can invest in high risk investments since he has got a long period of time before retiring. So he can afford maintaining a high risk portfolio whereas, a retired investor with a limited budget of monthly expenses cannot afford a financial loss. He has no time to recover the losses unlike the young investor!
Your willingness to tolerate risk is called your psychological risk which involves the emotional side of investing! Your behavior is more influenced by past investment experiences. It is the level of stress you can handle with the market ups & downs.
What is more important is…you must identify your own Risk Profile first & then build your portfolio accordingly. You may have one of the following Risk Profiles:
- Moderately Conservative
In the end it comes down to identifying and understanding all the risks you are exposed to. Decide which of those risks you fear most, and avoid them. Embrace the productive risks that have the potential to deliver higher returns. Devise a strategy to manage and control them. We cannot avoid risk; we can only select certain risks over others!