By Hemanth Gorur
Ask any investor what is her main fear while investing and her response will point towards the fear of losing money. In other words, investors fear the risk of investment, which is the likelihood of not getting returns on the principal amount invested, or even the principal amount itself.
While investors can vary in their appetite for risk while investing, many investors are not able to assess their own risk-taking ability, which is crucial for sound financial planning. The more risk you can take on, the more risk-seeking you are as an investor. In this case, you are more likely to suffer a loss, but you are also more likely to get higher returns, as risk and return go hand in hand. Conversely, the lower risk you are willing to take, the more risk averse you are, and the returns will accordingly be lower.
Here are simple rules to check if you are a risk-taking investor.
Your choice of investments
A cursory look at your investment portfolio will tell you whether you love to go for risky bets or not. If your portfolio comprises more of riskier financial products such as small cap equity stocks, equity mutual funds, forex, financial derivatives, or shareholdings in early-stage startups, then you are more likely a risk-seeking investor.
On the other hand, if your portfolio tilts more towards investments like time deposits, government bonds, debt mutual funds, or long-term land holdings, you are most probably a risk-averse investor.
Behaviour during bull runs
Stock markets are a good testing ground for assessing your risk-taking ability. There comes certain phases where the stock markets rise based on positive investor sentiment, or genuine good performance of listed companies, or both. Stock markets can enter into extended phases of such rise in stock prices. Such phases are termed as 'bull runs'. Risk-seeking investors tend to want to ride such bull runs irrespective of how long the bull run has lasted or what levels the stock markets have reached so far. Risk-averse investors, on the other hand, may ride the bull run initially but may tend to waver or hesitate to ride it beyond a point, fearing an imminent market crash.
Capital preservation versus growth
Investors typically confront a dilemma while investing or while exiting an investment-whether to aim for preservation of amount invested or to aim for growth of amount invested. This dilemma occurs whenever growth of investment requires decisions that conflict with attempts to safeguard the capital invested.
If you tend to take decisions that are more geared towards growing your investment, you are a risk-seeking investor, as opposed to risk-averse investors who would focus more on preserving their capital invested even if that means lower returns eventually.
Trade-offs made in investment decisions
The trade-off you make as an investor while taking financial planning decisions says a lot about your risk-taking ability. Consider a hypothetical scenario where you are asked to accept the possibility of a loss of Rs 1,000 in order to gain Rs 100 from an investment decision. A risk-seeking investor would focus on the gain of Rs 100 and would probably take up the gamble, while a risk-averse investor would probably baulk at the possible loss of Rs 1,000 and consider the gain too little to compensate for that, thereby rejecting the offer.
While risk is inherent in almost every financial product, it helps to self-assess your risk-taking ability and employ that knowledge to efficiently build an investment portfolio that matches your risk profile.
The writer is co-founder, Hermoneytalks.com and managing partner, Hubwords Media