Source: Business Line
"Can you suggest aggressive stocks that will double my money in a year? I'm willing to take high risk..." writes a 22-year-old software professional.
"Hey! The stock market swings by 200-300 points every day. I'd be crazy to risk my money in stocks when I can keep it in a safe savings account," avers a middle-aged banker. The first person likes the prospect of quick gains and equates risk with aggression, but does he understand that a "high risk" stock could be one that shaves 50 per cent off his investment in just a few weeks? The second investor wants to avoid losses by giving stocks a wide berth, but is he aware of the very real `risk' of inflation putting a big dent on his savings?
Though most people think stocks spell `Risk' with a capital R, most investments carry risk in one form or the other. It, thus, becomes important to resign yourself to assuming some risk, no matter where you invest! This is why, understanding risk and your own tolerance to it is one of the first steps to successful investing. Put simply, risk is nothing but the probability of losing money when you invest. Risk tolerance is your ability to take adverse swings in the value of the investment. So how can you gauge your ability to take risk? Here are a few factors that have a bearing:
Age: The younger you are, the higher your ability to take risk, because you can afford to wait out any temporary erosion in the value of your investment. A simple thumb-rule suggests that your allocation to equity should be 100 minus your current age (80 per cent of your portfolio in equities, if you are 20 years old!). But don't apply this blindly, there may be several exceptions to this rule.
Life stage and prospects: If you are salaried with the prospect of an expanding pay-check, you probably have a higher ability to take risk than someone who relies on his family business, which yields lumpy profits. If you are married and planning to start a family, you may have to allocate more to cash and fixed deposits than your single friend who only invests in stocks.
Current wealth: If you already have a stash of cash for emergencies and a nest-egg to meet your near-term goals, you could probably do some aggressive investing. But if you are running your finances on personal loans and maxed credit cards, you should not be taking the risk. Evaluate every fresh investment decision in the light of your existing finances and their adequacy to meet your immediate and essential needs.
"Hey! The stock market swings by 200-300 points every day. I'd be crazy to risk my money in stocks when I can keep it in a safe savings account," avers a middle-aged banker. The first person likes the prospect of quick gains and equates risk with aggression, but does he understand that a "high risk" stock could be one that shaves 50 per cent off his investment in just a few weeks? The second investor wants to avoid losses by giving stocks a wide berth, but is he aware of the very real `risk' of inflation putting a big dent on his savings?
Though most people think stocks spell `Risk' with a capital R, most investments carry risk in one form or the other. It, thus, becomes important to resign yourself to assuming some risk, no matter where you invest! This is why, understanding risk and your own tolerance to it is one of the first steps to successful investing. Put simply, risk is nothing but the probability of losing money when you invest. Risk tolerance is your ability to take adverse swings in the value of the investment. So how can you gauge your ability to take risk? Here are a few factors that have a bearing:
Age: The younger you are, the higher your ability to take risk, because you can afford to wait out any temporary erosion in the value of your investment. A simple thumb-rule suggests that your allocation to equity should be 100 minus your current age (80 per cent of your portfolio in equities, if you are 20 years old!). But don't apply this blindly, there may be several exceptions to this rule.
Life stage and prospects: If you are salaried with the prospect of an expanding pay-check, you probably have a higher ability to take risk than someone who relies on his family business, which yields lumpy profits. If you are married and planning to start a family, you may have to allocate more to cash and fixed deposits than your single friend who only invests in stocks.
Current wealth: If you already have a stash of cash for emergencies and a nest-egg to meet your near-term goals, you could probably do some aggressive investing. But if you are running your finances on personal loans and maxed credit cards, you should not be taking the risk. Evaluate every fresh investment decision in the light of your existing finances and their adequacy to meet your immediate and essential needs.
Apart from these, mindset plays a key role in your ability to assume risk. The best gauge of your ability to take risk is the extent to which you worry about your investments. If you are checking on your investments every few days (or god forbid, hours!) to see how they are faring, you are probably assuming far more risk than you are comfortable with. It is time to re-assess your risk tolerance, re-jig your investments and regain your peace of mind.
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