When it comes to investing, risk tolerance is an important component to consider. Depending upon your risk taking ability, you can decide your asset allocation to reach your financial goals.
Before you invest in a mutual fund scheme, you need to first consider a few points and to be clear about them.
1) What are your financial goals?
You may have many financial goals right from some short-term goals like buying a car, paying school fees to medium-term goals like buying a home, family vacation and long-term goals like retirement planning, children’s higher education and marriage. You need to plan separately for each goal.
2) How much do you need to save to reach your goals?
When your goals are clear, you can estimate how much you would need to save today to reach there after considering the inflation.
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3) What is the time horizon you keep to achieve these goals?
Time horizon that you have to reach at your goals is an important consideration while investing. There are mutual funds that are particularly meant for short-duration and there are also funds for long-duration goals like retirement.
4) What is your risk taking ability?
Your willingness and ability to take risk defines your choice of investments ultimately. Your current age, number of dependents, annual income, amount that you have set aside as emergency fund, amount that you can invest monthly, liquidity requirement, your willingness to take risk and return expectation etc are some of the key factors that define your risk profile.
Based on your risk taking ability, your asset allocation needs to be done. You can seek the help of financial experts to know your risk profile. Your risk profiling can be done with a simple questionnaire.
When you understand your savings requirement based on your financial goals, time horizon and risk profile, you can start knowing the suitability of each type of mutual fund with different risk-return characteristics as per your requirement.
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Selection of mutual funds as per your risk profile and asset allocation
You can choose the funds based on your risk profile and defined asset allocation for you across various asset classes like equity, debt, gold and real estate etc.
1) Aggressive/dynamic investor
You are an aggressive investor which means you are willing to take high risk in investments that have higher volatility. In such cases, you would also expect higher returns for maximising your wealth.
Equity mutual fund category is the ideal choice for your risk profile. You can consider to invest in some small-cap and mid-cap equity funds that come with relatively higher risk and potential for higher return.
You can also consider some sector funds that invest in stocks of particular sectors. Mainly, you need to also consider the investment horizon to reach your goals.
Equity mutual funds are well suited for capital appreciation and to achieve long-term goals. In case you have to invest for medium-term goals you can consider investing in equity-oriented balanced funds.
You can also consider investing a portion of your money into debt funds keeping in mind your short-term goals and liquidity requirements.
2) Balanced investor
You are a balanced investor, which means you are willing to take medium risks while investing. You would prefer to invest in financial avenues that are not highly volatile.
Medium-risk investors like you can consider to invest in equity mutual funds like bluechip funds or large-cap equity funds that invest in stocks of well-established companies for your long-term goals like for retirement corpus.
Though equity involves high risk, it can perform well over the long-run. You can also consider to invest in funds with a diversified equity portfolio. For your medium-term goals, you can consider investing in hybrid funds.
As hybrid funds invest in both equity and debt in an almost equal proportion, this can very well suit your asset allocation preference and risk taking ability. You can also invest a part of your money into short-term debt funds for liquidity purposes.
3) Conservative investor
You are a conservative investor, which means you are a risk averse or an investor with low risk preference. While investing, you would prefer avenues that can offer your stability and income rather than capital appreciation and growth.
You can consider investing in long-term debt funds for your long-term goals. You can consider retirement savings funds or pension funds. For regular income, you can consider investing in income funds. Credit risk funds can also be a good choice for your risk profile.
Defining asset allocation based on your risk profile is extremely important to successfully reach your financial goals. While selecting the best suitable mutual funds as per your risk profile, it is also important to consider your existing asset allocation and investments in other financial products.
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