How to Analyze Risk for Mutual Funds Investments?

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In the current times when everyone wants something extra, mutual funds have become the latest trends in the field of financial planning. The major reasons for this increasing popularity are the high growth possibilities associated with these schemes and the ease of investment. Now, while making investments, one major mistake that is made by a large number of investors is choosing a scheme on the basis of returns. Now, this may seem like a good choice during the market upside, but during the market downside, it causes a great panic, which eventually ends up with discontinuation of investments. To avoid this, one should always pick a scheme based on different factors, the major among which is how much risk they can handle. To ease the process of analyzing risk, in this blog we will discuss, how you can calculate your risk appetite before making an investment. Let’s take a look.

Now, measuring the risk on your own is a very tough task, and require extensive knowledge. But, to ease up this process for investors, our team has created a simple test, following which you can know your risk taking capacity. There are two types of risk factor associated with a person, the first is the financial risk, and the second one is the psychological risk. So, let’s start with some questions to calculate the financial risk.

Calculating Financial Risk Capacity

For calculating the financial risk an individual can take, there are 4 questions, and each question will have some options. Each option has some points, and based on your total points, your financial risk will be calculated.

Question 1: What is Your Net Worth?

1. Having only liabilities. (1 Point)
2. Net worth is up to 12 times the monthly expenses. (2 Points)
3. Net Worth is 13-36 times the monthly expenses. (3 Points)
4. Net worth is 37-48 times the monthly expenses. (4 points)
5. Net worth is 49-60 times the monthly expenses. (5 Points)

Question 2: How Much Savings You Make on Monthly Income?

1. Up to 5%. (1 Point)
2. 6%-15%. (2 Points)
3. 16%-25%. (3 Points)
4. 26%-50%. (4 Points)
5. 51%-75%. (5 points)

Question 3: How Many People Depend on You Financially?

1. No dependencies. (5 Points)
2. 1 dependency. (4 Points)
3. 2 dependencies. (3 points)
4. 3 dependencies. (2 points)
5. 4 or more dependencies. (1 Points)

Question 4: What is the Consistency (security) of Your Job in the Next Year?

1. High. (3 Points)
2. Moderate. (2 Points)
3. Low. (1 Point)

From the above options, pick those that best fits you, and calculate the total number of points you have scored. Based on these scores you can calculate your financial risk using the below range.

1. 0-7 Points (Very Low Risk)
2. 8-11 Points (Low Risk)
3. 12-14 Points (Moderate Risk)
4. 15-16 Points (High Risk)
5. 17-18 Points (Very High Risk)

Now, let’s move forward to the questions which will decide the psychological risk you can take.

Calculating Psychological Risk Capacity

Psychological risk test will help in knowing the tolerance level you have. This will basically decide how much fluctuations in returns you can handle in a particular time period. This test will contain 3 questions with multiple options. Each question will have some points, which will help in getting the final results.

Question 1: How Much Knowledge You Have About the Market?

1. No knowledge. (1 Point)
2. Beginner level. (2 Points)
3. Intermediate level. (3 Points)
4. Expert level. (4 Points)

Question 2: How Much Fall You Can Handle on Your Investments in a Month?

1. 0%-5%. (1 Point)
2. 6%-10%. (2 Points)
3. 11%-20%. (3 Points)
4. 21%-30%. (4 Points)
5. More than 30%. (5 Points)

Question 3: For How Long Can You See Your Investments in Negative?

1. Less than 3 months. (1 Point)
2. Between 4 months to 1 year. (2 Points)
3. Between 1 year to 2 years. (3 Points)
4. Between 2 years to 3 years. (4 Points)
5. Between 3 years to 5 years. (5 Points)

Now, here too using the options you have picked calculate the total points you have gained. Using these, you can decide which band you fall in.

1. 0%–5% (Very Low Risk)
2. 6%–8% (Low Risk)
3. 9%–11% (Moderate Risk)
4. 12%–13% (High Risk)
5. 14%–15% (Very High Risk)

Using the above questions you would have attained an answer that in which risk band you fall in. Further, we will see, what the different risk profiles mean.

Understanding the Risk Profiles

1. Very Low Risk: People with very low risk appetite can’t handle any kind of risk with the investments, and have the capacity to handle 5% loss for up to 3 months.
2. Low Risk: Individuals with low risk appetite have a small financial backup, so can take a bit of risk. They can tolerate a fall of 5%-10% for a period of 4 months to 1 year.
3. Moderate Risk: People with moderate risk appetite can take a mediocre risk with their investments, and can tolerate a downfall of 10%-20% for a period of 1 year to 2 years.
4. High Risk: People with high risk have a strong financial back up so can take high risk with investments, and can handle 20%-30% fall in returns for up to 3 years
5. Very High Risk: Financial strength is very high, and can tolerate negativity of more than 30%, for a period of 3 to 5 years.

Now, use the process to find out your risk tolerance and then pick the investment options accordingly to avoid panic in future. In case you face any problem while accessing the risk, or choosing the appropriate schemes, feel free to connect with the experts.