It is essential to choose a fund based on the level of risk you can afford to take to get the best returns from mutual fund investments.
So how much risk can you take? Many answer it without much thought, especially novice investors who may take risks without fully understanding the consequences.
Most people, particularly those investing in mutual funds, choose investments without proper risk analysis. While good stock market investments often deliver solid long-term returns, the real question is whether they will be profitable when you need the money. Diversifying your portfolio according to your risk appetite can help manage this challenge.
How to calculate the risk?
Nowadays, it only takes a few minutes to calculate the risk. Simply search for a ‘risk calculator’ on Google, and you’ll find several websites that can help determine how much risk you can reasonably take. By answering a few questions, these tools can help you determine what percentage of your investment should be allocated to various categories such as equity, gold, and debt. However, long-term investors who invest large sums of money are better off seeking the services of financial experts.
Some preparation is required before opening websites to assess risk. Each website uses different questions to assess risk. These questions should be answered with utmost honesty. Common questions that you can expect:
1. How much can I invest?
You need to have a clear idea of how much (percentage) of your total income you can allocate for investments. You should calculate the investment amount by looking at expenses, loans, etc. There are risk calculators that ask questions about EMI, annual income, and job stability.
2. How much is the share?
What percentage of your total investment are you willing to invest in a high-risk, high-return sector? This question should also have a clear answer. For example, if you are planning to invest ₹10,000 in a mutual fund, you also need to have an idea of how much you should invest in a small-cap sector that is a high-risk category. Here, you can consider the investment period, and the amount required to meet the financial goal, etc.
3. Ability to cope with loss
Everyone wants to grow their wealth and dreams of becoming rich. But what would you do if the stock market crashed due to a crisis like Covid or any other reason? How would you react if your investments showed negative growth for an entire year? Would you sell your holdings out of fear? Or would you continue investing in hope that the market recovers? Or would you take it as an opportunity to invest more? Also, how much of a loss percentage can you afford in a single year?
These are the questions that every investor must answer before investing.
Often, it’s the past performance of the stock market that attracts new investors. You may even plan your investments expecting similar returns. But the truth is that the market’s wont give the same returns as it is volatile. So, that’s why you should also plan for situations if the investment does not achieve the expected growth.
Other important factors
Here we discussed common questions that are often found in risk calculators. In addition to these, there will be questions such as age, experience in the stock market, investment period and number of dependents. If you answer all of these honestly, you can calculate your own risk for free.
Types of risk
Between low-risk and high-risk investments, risks are generally categorised into three main levels: moderate, average, and aggressive. Each category reflects a different level of risk tolerance and investment behaviour. With the help of risk calculators, you can accurately determine where you fall within these categories. Calculating risk will help you find answers to questions like which mutual fund to choose. Am I investing sufficiently? etc
