On a routine walk last week, the light drizzle was a welcome relief for me from the heat and humidity that was building up. As the drizzle increased, I could see concerned parents fish out large umbrellas to protect their children from the raindrops, old men make valiant run for shelter to save themselves from getting wet and the newspaper vendor take a huge sheet to cover his wares and not himself. While I was happily humming one of my favourite rain songs, I observed that everyone had a different method to address the risk of getting wet.
For much of human history, risk and survival have gone hand in hand. Right from the moment we get up in the morning, drive or take public transportation to work, till we get back into our beds, we are exposed to risks of different degrees. While we may not have much of a control on some risks, we seek out some risks on our own (speeding on the expressways or betting over a cricket match, for instance) and enjoy them. Some of these risks may seem trivial, others make a significant difference to the way we live our lives, especially the risks we take with our finances. We all know or have heard that investing is a powerful tool to increase one's wealth, and many of us blindly get into investing for one reason or the other. However, at the time of investing, we do not ask ourselves: What is this investment for? What are the products I need to consider?
Getting into investing without a clear understanding of the process involved is like setting off on a treasure hunt without a map and clues. It is not difficult to understand why and what investing is, and once you understand these two aspects, choosing the right financial product to meet your needs will be easy.
The first step to investing is to understand the purpose of the investment, to determine your risk tolerance and the kind of products that would suit your risk profile. For instance, at 40, when I am planning for my retirement at 60, I don't need the money for another 20 years. Hence, the kind of risk I can take will be higher as I can withstand the ups and downs of the stock markets and stay invested. On the other hand, if the money that I have is meant for rainy days, then my purpose is to protect my savings so that in case of unfortunate events, there is cash available to help me tide through the problems. Therefore, the risk tolerance will be very low for this money and the type of products I choose will have to meet this need.
While your age and your time frame for meeting specific financial goals play a role in determining your risk tolerance, there are also other factors that affect your tolerance for investment risk. Your personality, personal experiences, and current financial circumstances also come into play. For instance, if you're the sole breadwinner responsible for the care of a sick or an elderly relative, or have lived through a period of economic downturn, you may be a more risk-averse, or conservative, investor. On the other hand, if you have a promising career, a generous salary, and little in the way of financial responsibilities, you may be more comfortable in taking greater investment risk.
A simple way to check your risk tolerance is to ask yourself how comfortable you are in taking risks. For instance, if changes in the value of your savings and investments keep you fidgeting and worried, or your instinct is to sell your investments every time the market drops, then you may want to consider shifting to a more moderate investment mix, with greater emphasis on predictable, income-producing investments such as fixed deposits or traditional life insurance.
If you're a risk-taker by nature and have at least 15 years to meet your goals, then you may be comfortable allocating most of your assets to a diversified portfolio of stock, equity funds, and unitlinked insurance plans, along with certain fixed-income investments that have the potential to provide the strongest returns over the long run.
The decisions on how much risk to take and what type of risks to take are critical to the success of your investments. You can get a clear view of your risk-taking ability with professional help and a scientific risk profiler.
Life insurance forms the bedrock of all financial planning and the best way to begin one's financial journey. The needs and goals in a person's life keep changing and a periodic re-evaluation of your mix of asset allocation, time horizons, liquidity and risk-return equation is necessary to optimise the desired outcomes.
Keeping this mantra in mind, make the right choices of financial products and your invested money can go up in value. But with the wrong choices, you may end up losing it all.
