Know Your Risk Tolerance Before Investing in Equities

Dear Reader,

With significant increase in retail investors participation during last few years, stock prices were on rise with mid & small cap index making all time high in Jan 2018 last year. As many new investors get into stock market during such times, its always important for an individual investor to understand what is his/her investment profile and risk tolerance.

From Jan 2018 onwards, with lot of pessimism building around equity market due to global as well as domestic factors, we have seen severe correction in broader markets over next 14 months. Since beginning of last year, we have seen severe correction in broader indices. Even after pre election rally in markets, BSE Small Cap & BSE Mid Cap Index is still down by 26% & 16% respectively from their all time high made in January last year. Steep fall in broader indices have hurt sentiments and created panic for many of retail investors who got into market during last couple of years. Its important to know, whether you would be able to hold on your equity investments, think to exit if stock market tanks further or accumulate good companies available at reasonable to attractive valuations after a long time. 

Its always wise to be greedy when others are fearful. Fall in stock prices of small and mid cap companies by 40% to 60% from their peaks use to happen during panic times, if a particular company delivers 3x to 5x or even 10x type of returns on your investments in period of 3 to 7 years, it can easily fall by 40% to 60% or even more from its 52 week high during tough times which arises due to profit / loss booking, series of negative events / news flows and severe sell off due to panic across markets. Below are some of the major reasons of severe fall in stocks prices of small & mid cap stocks since beginning of 2018:

We always suggest our members not to time the market and follow a disciplinary approach while investing in equities with medium to long term perspective. Its important to know, whether you would be able to hold on your positions in case stock market tanks? However, such severe corrections do not come very often and hence must be considered as buying opportunity to aggressively add on good quality stocks at discounted prices keeping a long term view. If you are a long term investor, its wise to be greedy when others are fearful.

Historical data indicates that most of the new investors get fascinated towards stock market to make quick bucks and finally end up loosing their capital as they cant hold on their stocks in case market corrects and sell out their stocks in a panic. Stock market is not a money making machine, you need not to be greedy on rising market or fearful when stock market falls, simply buy right and sit tight having sufficient patience with you to see your investment growing over a period of time.

We strongly recommend our members (who are new to stock market) to kindly go through our Asset Allocation Questionnaire to understand your investment profile and risk tolerance.

By answering 15 questions about your risk preferences, you can find out your investment profile and risk tolerance. This score will determine the asset allocation that best suits your risk preferences, you can use our simple excel workbook - Saral Gyan Asset Allocation Questionnaire which suggests the optimum split between cash, bonds and stocks.

The questions are simple to answer, with options provided to select answers using drop-down list, check boxes and radio buttons. They are designed to determine your tolerance to investment volatility, the size of your existing financial cushion, your time horizon, and what you want your investment to achieve.

1.What is your total annual income before tax (including investment dividends but not including employment bonuses)?

2.How many sources of income do you have?

3.What is the value of your liquid (or investable assets)? This includes cash plus any easily sold investments like Gold, Bonds and Stocks.

4.What yearly income do you want from this investment portfolio?

5.How long do you intend to hold this investment portfolio?

6.What would you do if your investment portfolio fell in value by one-fifth (20%) over the course of 12 months?

7.What characteristics would you prefer your investments to have?

8.Do you prefer investments which have low volatility and low return, or investments which have high volatility and high returns?

9.What do you want this investment portfolio to do? Preserve capital, generate income, generate income with some capital appreciation etc.

10.What volatility (or risk) are you prepared to tolerate?

11.In the next five years, what percentage (if any) of the portfolio do you plant to sell to realize cash?

12.What kind of investments do you currently own, or would prefer to own? Domestic, international, aggressive, fixed income etc.

13.Assuming a time horizon of ten years, what annual return do you want?

14.Who do you normally get investment advice from?

15.How would you rate your current skill in managing investments?

Your answer to each question is rated with a score. The total score is used to suggest an asset allocation that is appropriate to your risk preferences; the workbook suggests a split between:

■ Cash

■ Bonds (high-yield, long-term, intermediate and international)

■ Stocks (large cap, mid cap, small cap and micro cap stocks)