Find out your Financial Risk taking ability
Being an Equity analyst, every day I meet with several persons want to invest in equity but don’t know “what is the appropriate percentage of income in investing in equity or in a single term, how much risk they can take”.
We, generally use the term “risk” with Equity Investment because as a general people watch that there is a huge up-down in the equity market, so it is risky. But do you know that investment in good companies at least for more than 5 years is very safe? Yes, most of the people doesn’t know this and even they have this knowledge, downside in the market and huge paper-loss make them panic to sell off all his equity investments and forced to make actual loss. So, for general public, equity investment is risky.
Basically our Financial risk appetite depends on 5 things, namely:- age, income, liabilities, dependands and the field of work. Let me explain one by one.
Age is the most important factor of your risk profile. The younger you are the higher capacity of taking risk. Because, being a younger one, you can get more time for long term investment in good equity stocks. In equity investment; time is a very important factor.
Normally, some financial planners say that your equity allocation should be 100 minus your age. Like: – as per this rule, if you are 25 then your equity allocation should be 75% of your total investment but Obviously THAT SHOULDN’T BE! There are also many factors to decide your risk appetite.
The amount of income always impacts the risk- profile. Self-employed professionals, like- lawyers, Equity analyst (like me), Digital marketers, don’t get regular payment on monthly basis . They need to keep good amount of liquid cash in hand for emergency basis or they require keeping their investment in such a way where liquid cash is available in a day.
But a salaried individual has a regular stream of income and can opt for the instrument which have short term risk but give high return in long term, like long term investment in equity.
If you have any loan outstanding then avoid taking risk in your investment. Ideally, your debt payment should not be more than 50% of your income.
But it is always try to repay the loan as soon as possible. It is better to pay the principal amount of loan than to invest in somewhere also (of-course, there should be a contingency fund always).
As an example, if your income is good as per your daily expenses and you are paying only 30% of your income for this repayment of loan then your debt-income ratio is good but have you noticed the interest amount you are paying every month? As per the statistics, If you have any long term loan like-home loan then after 10 years of payment you will see that you have paid nearly 70% of your home purchase amount just as interest, not the principal. So, in a single word, your very first financial goal will be become a debt-free person and then other investments. Always try to avoid long term loans.
The dependency level of a person also affects his risk-tolerance. If he is the only bread-winner in a joint family (spouse, children, parents, siblings), he should not invest his hard-earned money in a risky area. Basically, at this situation, this person needs lot of insurance (life , health, disability and others) and greater amount of emergency funds.
On the other hand, in a small family where the person having working spouse, can take lot a risk in his investment.
E. Field of Works:
The industry or the place of work determines the stability of the income. Someone working in a new small company should not be as aggressive as someone working in a stable big company.
Now, you have understood the factors which decide your risk-tolerance but you may have one question that
WHAT is MY RISK-TAKING-CAPACITY?
Let’s find out your risk-appetite with this simple question-answer session.
Q1. How stable is your job/profession/income path?
1. Not Sure at all
2. May need to change soon
3. Don’t foresee any change
4. Doing fine and there is expectation of rising
5. High chance of Growing well
Q2. One’s main income source may be from business/salary and other sources may be rent, interest, dividend, income of your spouse, etc. Your Total Family income comes from
1. From 1 source (business/salary)
2. 2 sources
3. 3 sources
4. 4 sources
5. More than 4 sources
Q3. Depending on your current status, can you achieve your short term and long term Financial goals?
1. May be not possible to fulfill all
2. May be possible but with a bit of struggle
3. Yes, possible. Our planning is good and we are on correct track.
4. Our planning is ready and have enough fund to achieve the future goals
5. All goals are achieved
Q4. How soon do you need lump sum money to fulfill any of your dream/goal?
1. Within 6-12 months
2. 1-3 years
3. 3-6 years
4. 6-10 years
5. More than 10 years
Q5. The amount of repayment your loans/debts
1. Over 50% of your income
2. 30-50% of your income
3. 10-30% of your income
4. Less than 10% of your income
5. No loans
Q6. How many times you rolled forward your credit card bills or how many times you have borrowed in last 1-3 years
1. All the time
2. About 5-7 times
3. 3-4 times
4. 1-2 times
Q7. What is the number of your dependants?
1. More than 5 (includes parents, siblings, spouse and Children)
2. 4-5 (Parents, spouse and Children)
3. 2-3 (Spouse and Children)
4. 1 (Only Spouse)
Q8. How many years are left for you to take retirement?
1. Already retired
2. Less than 10 years
3. 10-20 years
4. 20-30 years
5. More than 30 years
Q9. How much do you save compare to your income?
1. Less than 5%
5. More than 30%
Q10. Which of these best describes your Financial Situation?
1. Very unstable
2. Need lot of improvement
5. Going Excellent. No need to worry at all.
Our question-answer session is now completed. It’s time to calculate your score. Just take the answer no of each question as the point no, like- if you choose the answer of the question no 10 as “GOOD” then your point for that question will be 4.Take the point of each questions and sum it up to find out your final score.
Depending on the scores find out what type of investment you should follow now.
OVER 36 POINTS: Can take Aggressive Investment Decision
Currently you are in excellent position. No need to worry at all. You can take high risk. You can put more than 80% (even 90% also) in Equity. If you have good knowledge in Equity then make this Equity investment in two groups, i.e. short term (within 1 year) and long term (more than 5 years). Make this ratio as 1:2. In short term, you can earn profit more than 30% p.a. easily under good advice.
29-36 Points: Risk Appetite is average risk aggressive
You can take above average risk. You can make 60-70% of your investment in Equity long term. But if you want to invest in short term Equity then don’t make it more than 10-15% of your investment. Income from your stable investment, like investment in debt will help you to manage the ups and downs of the equity sector.
21-28 points : Average
You can take moderate risk while choosing your investment vehicles. In term of Equities, you can invest maximum 50% in long term Equities. If you are very much interested in short term profit from equity then invest just 5% of your total investment in Short term Equity and 45% in long-term Equity and balance in debt.
13-20 Points: Less than average risk taking capacity
Your risk appetite is quite low. Strongly avoid short term equity investment. Make long-term equity investment not more than 30% , 20-25% in good balanced Mutual Fund and rest in the safety of debt.
Below 12 Points: Conservative
You can’t take any risk. You need to protect your capital even it gives you low returns. Invest in very safe areas. In case of Equity investment concerns, can invest only 5-10% of total investment in long term equity in very good stocks. Never ever think to invest in short term equity or any other riskier investment places.
Now you are clear about your risk-profile. But always keep in mind that irrespective of your risk-profile, always make required health and life insurance . In today’s lifestyle, these insurances are not the choice at all but these are the necessity of our daily life. Suppose, you don’t have any health insurance for your family members and one of your family member become ill. Then within few days, huge money can be spend and even this may hamper your future financial goals also. So, always be prepare with required liquid contingency fund, insurance and proper investment.