Know what type of investor you are before you start investing

Investing is a risky business. Key to successful investing is to identify your risk profile and invest accordingly. A conservative investor will have sleepless nights if he invests in the volatile stock market.

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Risk is also normally associated with age. A younger person can afford to invest in the equity markets but that might not be the case with an elderly person, especially one who is nearing retirement.

Before one starts investing it is important to know the kind of investor he or she is. Your investment profile will define the type of investor you are. Various factors like your age, financial condition, investment goals and risk taking ability comes in play.

Defining risk

Risk or risk taking appetite is simply put, the amount you can afford to lose. It is a vital element in defining your investment profile. The more risk you can take the higher the potential returns you might make from your investments.

Younger investors, who generally have a higher risk taking ability can invest smaller amount in the riskiest asset class to plan for their return. Even if they fail in the short term they have time to rectify their mistakes and shift to conservative investment products. Those investors nearing retirement, should ideally look at less volatile markets which might affect their return but at least will not eat into their capital.

Risk Profiles

Risk profile of an investor can be classified into low, medium or high.

Conservative (low risk)

Such type of investor are more concerned about their capital. They cannot see any erosion in their capital. Such investors prefer high quality debt and money market instruments, where they do not mind lower and steady returns and see a moderate growth in their capital.

Balanced (medium risk)

A slightly more riskier investor who can take a little bit of choppiness in the value of his portfolio is a medium risk investor. Here the portfolio will be slightly volatile but the returns can also be higher.  The assets in a balanced portfolio include a mix of shares and bonds from stable companies. A small proportion of the portfolio may even be invested in riskier assets in order to deliver better capital growth.

Aggressive (high risk)

An aggressive investor, as the name suggests, is one who is prepared to expose his portfolio to high  risk and higher volatility for the sake of capital growth. Such investors are willing to expose themselves not only to volatile equity markets but also invest in small and unknown companies that are expected to do well. Further, they are also willing to invest through leveraged derivative products. This kind of investing is not for the faint hearts and certainly not for those with limited capital.

Risk and return

Risk and return are directly proportional. Lower the risk lower is the return and higher the risk higher is the return. But risk can be mitigated even by aggressive investors by diversifying his portfolio. By investing in a wide variety of unrelated stocks risk to some extent can be mitigated but cannot be removed.

Risk, returns and goals

Having identified yourself as the type of investor is essential before selecting the instrument you will be investing in to meet your goal. An equity investment might require lesser capital and lesser time to reach your goal, but it might not be the best thing for you. One might be tempted to classify himself or herself as an aggressive investor when the difference in returns for the same capital is theoretically calculated for various asset class. Thus identification of the type of investor you are should be sunk in before you move to select instruments to achieve your goal.

Risk, returns, goal and age

Wealth creation requires time as well as money. Compounding works in your favour if you have time on your side. The longer you stay invested, the higher are the chances of earning good returns. Younger people have time on their side and therefore, generally, a higher risk taking capacity.

But as you mature with age it is advisable to shift your investment to lesser riskier ones, especially when your financial goals are near.

Map your risk profile

If you were given to invest in only one asset class for one decade, how would you, as a reader, like to invest in your lifetime. Send us your replies.