Risk Profile-based Investment Options.

 

W

e should keep in mind, Investments and Savings are two different things altogether. If you are Saving part of your salary or income it is not your investment, investment is what you applied to earn for yourself. Investments are made to meet Long term Goals, whereas Savings are used to meet short-term goals. Every middle-class person has some needs or targets that they want to achieve. But due to a lack of financial knowledge and management, they just work for money, and even if they put their savings into a bank account or fixed deposits, it will not help them to reach their financial targets. Everybody earns and saves money by keeping it aside in their pocket, or somewhere where it is safe, instead of investing, your money doesn't work for you henceforth your money will never grow. Now, comes the question Why to invest? There are multiple reasons why one should invest.

Reasons why we need to invest?

• If money is lying in your savings account, it gives us a minimal return
• Inflation decreases our purchasing power every year.
• Our financial goals change very often
• Our tax structure is different from other countries
• Our medical costs are rising
• Expenses towards our children's education are rising every year

Investment simply means employing cash or assets to increase its current value or generate profit. In Layman Language, investment can be said as money used to make more money. Anything which gives you returns is “Investment”. 

The investment ensures present and future long-term financial security. The money generated from your investments can provide financial security and income. Not investing, or not doing it properly can mean a longer working life. When taking investing seriously, the returns generated from your investments can provide financial stability in the future. By making investments, you are also saving and accumulating a corpus for a rainy day. Apart from that, making regular investments force you to set aside a sum regularly, thereby helping you instill a sense of financial discipline in the long run. 

 

How does the risk profile decide what is the best way for people with different risk profiles to invest?

 

Before investing in any financial instruments. An investor should always check his risk appetite. Investing in the financial market carries some inherent risks, which can be classified into systematic and unsystematic risks.  

Systematic Risk: Systematic risk is also known as undiversifiable risk. The risk cannot be avoided or cannot be predicted before its occurrence. Systematic Risks include corporate interest rate changes, inflation, recessions, and wars.

Unsystematic Risk: Unsystematic risk is a company-specific or industry-specific risk. These risks are diversifiable. If an investor owns just one stock or bond and something negative happens to that company the investor suffers great harm. But if an investor owns a diversified portfolio of 20, 30, or 40 individual investments, the damage done to the portfolio is minimized. Unsystematic risks include business risk, financing risk, credit risk, product risk, legal risk, liquidity risk, political risk, operational risk, etc. Unsystematic risks are considered governable by the company or industry.

 

There are mainly three main types of risk profiles of investors

Conservative: Low Risk Capacity + Low Risk Aversion = Conservative Investors.

Investors with low willingness and risk-taking ability and who want their capital to be safe, less bothered about the rate of return on their capital are known as Conservative Investors. Equity is not recommended to such investors. These investors are advised to invest in Debt Funds and Bank FD’s.

Moderate: Medium Risk Capacity + Medium Risk Aversion = Moderate Investors.

Investors who are moderate in their risk-taking ability, who are willing to take a certain amount of risk to get higher returns. Are ready to accept short-term losses to gain higher returns in the long run. We call this type of investor moderate investors.

Aggressive: High Risk Capacity + High Risk Aversion = Aggressive Investors. 

Investors having high risk-taking ability and willingness are defined as Aggressive investors. Aggressive investors get a higher return as compared to all other types of investors. They invest a large amount of their capital in Equity.

 

Investment options based on their Risk

 Equity: In the context of stock market investments, equity refers to the shares in a company’s ownership. On investment in a company’s stocks, Investors can earn profit via capital gains or stock price appreciation. Further, investing in a company’s shares also bestows an individual with a right to vote in matters about the Board of Directors.

Investing in equity shares is popular among individuals because they are high-return investment options. However, despite their potential to bear high returns, they also expose an individual’s investment portfolio to a certain degree of risk.

 Mutual Funds: Mutual fund is a financial instrument made up of a pool of money collected from many investors to invest in securities like stocks, bonds, money market instruments, and other assets. Risk appetite in Mutual funds ranges from high to medium depending upon the scheme investors opting for.

The investor owns units, which represents a portion of the holdings of the fund. The income/gains generated from this collective investment are distributed proportionately amongst the investors after deducting certain expenses, by calculating a scheme’s “Net Asset Value”(NAV).

 Fixed Deposits: Fixed deposits can also be said as a traditional investment option. A fixed deposit investment scheme is provided by Banking and Nonbanking financial institutions. The fixed deposit has fixed tenures and a fixed rate of interest which investors will be earning. It can be said as fixed deposits are very safe to invest in.  

 

Conclusion: It can be concluded as People should invest in any of the financial instruments to meet long-term goals. Before parking money, one should always research and diversify their investment as per their risk-taking appetite and depending upon their expectation of earning gains or profit concerning the level of risk they are taking. Equity is advisable for high-risk takers (aggressive investors), mutual funds is a good option of investing for moderate risk takers and Fixed deposit can be said for conservative investors.