Your investment objective & risk profile
Like any purchase decision, your selection of a mutual fund scheme should be based on your expectations and the funds' ability to fulfill these goals. It is important to be clear about your investment objective before you enter into a buying decision.
If you are planning to build a mutual fund portfolio, the first step is to examine your current situation. Ask yourself questions like:
1. Why am I investing in a mutual fund?
2. What kind of returns do I expect?
3. What portion of my net worth would I like to set aside for investments?
4. What do I intend to use the gains for? How many years do I have?
5. What is my investment objective?
a. Capital Appreciation
b. Capital Preservation
c. Achieving sustainable long term growth
d. Combination of Income and Capital growth
6. What kind of risk am I willing to take in the long run?
Be Clear About Your Investment Objectives
Investment objectives can be broadly classified into:
1. Generating an additional source of income
2. Financing future needs
a. Buying a home
b. Building a retirement corpus
c. Child's education and marriage
d. Legacy Planning
3. Increasing savings/ Inducing savings
4. Reducing tax liability
5. Protecting your savings from inflation
Evaluate Your Risk Appetite
To fulfill any investment objective, investors should first evaluate their risk appetite. While some investors are satisfied by investing in a low-risk : low-return scheme, others are willing to endure short-term loss for long-term potential gains.
A risk profile offers you suggestions about the investment options that best suit your needs and lifestyle.
Factors That Determine Your Risk Appetite
1. Current Scenario - Your age, financial dependents, assets and liabilities, sources of income, level of engagement (active or passive investor) and investible capital
2. Past Experience - Knowledge about investment products, inclination to learn, nature and composition of the last held portfolio and its performance
3. Future Outlook - Time horizon available to fulfill the investment objectives, liquidity requirements in the near future, importance of tax savings vis-a-vis return on investment
4. Investment Attitude - Willingness towards risk taking, ability to withstand short-term notional losses in return for long-term high returns
Based on your responses, an experienced advisor can determine your risk appetite and classify you as a conservative, assertive or an aggressive investor (there could be as many as five to seven investor classifications suggesting different debt-equity allocations).
Mutual Fund Types Based on Risk Profile
Your risk appetite is an important factor while choosing the mutual funds scheme/s that fits your goals of growth, stability and timeframe.
1. A conservative investor's primary objective is to preserve the capital and receive regular income. They have a low tolerance for risk and hence a major chunk of their investment should be allocated to debt or money market mutual funds like income schemes, FMPs, etc.
2. A moderately aggressive investor is the one who is willing to take controlled risk for moderate returns. Such investors are generally recommended a mix of balanced, income, and index schemes so that they can benefit from a balanced portfolio.
3. Aggressive investors consider risk as an opportunity and leverage their experience and knowledge to take intelligent financial decisions. The major share of their investment, therefore, goes to growth and equity schemes.
For most investment schemes, risk and returns are directly proportional. It is important to create the right balance between the two based on your objectives and risk appetite.