The basic thing is about your ability to take risks and willingness to take risks. This distinction is lost on most investors. Most investors also become adventurous when the market is doing well. They become risk-averse when the market enters a bad phase. So, it’s very crucial that you understand the difference between your ability to take risks and your tolerance for risk.
The ability to take risks is whether you can afford to take the risk associated with an investment. For example, you may be extremely rich. That means you can afford to take risks. The opposite scenario can also happen. You have modest resources and you can’t afford to take risks. The next is your willingness to take risks. It is also known as your tolerance for risk. For example, a rich person can afford to take risks, but he doesn’t like to take risks. Another person may be willing to take more risks.
Therefore, it is important to understand the distinction between these two aspects and strike a balance between them. If you totally avoid risks, you may choose very safe investments. That means you will earn very poor returns. If you take too much risk, you risk losing your capital.
We always ask investors to choose mutual funds based on their goals, investment horizon, and risk profile. If you are investing for a few weeks, your prime objective is to preserve your capital and earn better post-tax returns. Then your choice is a debt mutual fund like a liquid fund. If you are investing for a year or so, again your choice is a debt fund like a money market mutual fund. What if you are investing for three years or more? You may choose debt mutual funds like corporate bond funds and Banking & PSU Funds. We don’t ask readers to invest in gilt funds and long term debt funds because we believe regular investors will find it difficult to take a call on interest rates and time their investments. Long term debt funds and gilt funds are extremely sensitive to interest rate changes. They lose when rates go up.
If you are investing for five to seven years and willing to take risks, you may invest in equity mutual funds. Remember, equity or stocks are extremely risky. You can lose money but you can also earn superior returns. That is the risk you are taking when you are investing in equity mutual funds. Equity is extremely risky in the short term. However, the risk becomes less when you are investing for a long period.
What if you are ready to take risk but want to avoid extra risks? In short, you want to create wealth over a long period without too much risk and volatility. That means you are a conservative equity investor, such investors should choose large cap mutual funds. As the name suggests, these funds invest in very large companies that are extremely robust. They are least volatile and they fare relatively better in a bad market. If you are willing to take little more or moderate risk, you may invest in flexi cap funds. These schemes invest across market capitalisations and sectors.
There are many choices like large & mid cap schemes, mid cap schemes, small cap schemes, sectoral schemes etc for aggressive investors. Remember, these schemes are risky and you should invest in them only if you know and understand the market. You should also have a longer investment horizon and ability to withstand volatility and possible losses.