Saturday, April 2, 2016

What Is Your Risk Tolerance?

Courtesy : Investopedia

Risk tolerance is a topic that is often discussed, but rarely defined. It is not unusual to read a trade recommendation discussing alternatives or options based on different risk tolerances. But how does an individual investor determine his or her risk tolerance? How can understanding this concept help investors in diversifying their portfolios? 

Risk Tolerance by Time frame


An often seen cliché is that of what we'll refer to as "age-based" risk tolerance. It is conventional wisdom that a younger investor has a long-term time horizon in terms of the need for investments and can take more risk. Following this logic, an older individual has a short investment horizon, especially once that individual is retired, and would have low risk tolerance. While this may be true in general, there are certainly a number of other considerations that come into play. 

 
First, we need to consider investment. When will funds be needed? If the time horizon is relatively short, risk tolerance should shift to be more conservative. For long-term investments, there is room for more aggressive investing. 

Be careful, however, about blindly following conventional wisdom. For example, don't think that just because you are 65 that you must shift everything to conservative investments, such as certificates of deposit or Treasury bills. While this may be appropriate for some, it may not be appropriate for all - such as for an individual who has enough to retire and live off of the interest of his or her investments without touching the principal. With today's growing life expectancies and advancing medical science, the 65-year-old investor may still have a 20-year (or more) time horizon.

Risk Capital

Net worth and available risk capital should be important considerations when determining risk tolerance. Net worth is simply your assets minus your liabilities. Risk capital is money available to invest or trade that will not affect your lifestyle if lost. It should be defined as liquid capital, or capital that can easily be converted into cash. Therefore, an investor or trader with a high net worth can assume more risk. The smaller the percentage of your overall net worth the investment or trade makes up, the more aggressive the risk tolerance can be.


Unfortunately, those with little to no net worth or with limited risk capital are often drawn to riskier investments like futures or options because of the lure of quick, easy and large profits. The problem with this is that when you are "trading with the rent" it is difficult to have your head in the game. Also, when too much risk is assumed with too little capital, a trader can be forced out of a position too early.
On the other hand, if an undercapitalized trader using limited or defined risk instruments (such as long options) "goes bust", it may not take that trader long to recover. Contrast this with the high-net-worth trader who puts everything into one risky trade and loses - it will take this trader much longer to recover.

Understand Your Investment ObjectivesYour investment objectives must also be considered when calculating how much risk can be assumed. If you are saving for a child's college education or your retirement, how much risk do you really want to take with those funds? Conversely, more risk could be taken if you are using true risk capital or disposable income to attempt to earn extra income.
Interestingly, some people seem quite alright with using retirement funds to trade higher-risk instruments. If you are doing this for the sole purpose of sheltering the trades from tax exposure, such as trading futures in an IRA, make sure you fully understand what you are doing. Such a strategy may be alright if you are experienced with trading futures, are using only a portion of your IRA funds for this purpose and are not risking your ability to retire on a single trade. 

However, if you are applying your entire IRA to futures, have little or no net worth and are just trying to avoid tax exposure for that "sure thing" trade, you need to rethink the notion of taking on this much risk. Futures already receive favorable capital gains treatment capital gains rates are lower than for regular income, and 60% of your gains in futures will be charged the lower of the two capital gains rates. With this in mind, why would a low net worth individual need to take that much risk with retirement funds? In other words, just because you can do something doesn't always mean you should. 

Investment Experience

When it comes to determining your risk tolerance, your level of investing experience must also be considered. Are you new to investing and trading? Have you been doing this for some time but are branching into a new area, like selling options? It is prudent to begin new ventures with some degree of caution, and trading or investing is no different. Get some experience under your belt before committing too much capital. Always remember the old cliché and strive for "preservation of capital." It only makes sense to take on the appropriate risk for your situation if the worst-case scenario will leave you able to live to fight another day. 


Careful Consideration of Risk Tolerance.

There are many things to consider when determining the answer to a seemingly simple question, "What is my risk tolerance?" The answer will vary based on your age, experience, net worth, risk capital and the actual investment or trade being considered. Once you have thought this through, you will be able to apply this knowledge to a balanced and diversified program of investing and trading.

Spreading your risk around, even if it is all high risk, decreases your overall exposure to any single investment or trade. With appropriate diversification, the probability of total loss is greatly reduced. This comes back to preservation of capital.Knowing your risk tolerance goes far beyond being able to sleep at night or stressing over your trades. It is a complex process of analyzing your personal financial situation and balancing it against your goals and objectives. Ultimately, knowing you risk tolerance - and keeping to investments that fit within it - should keep you from complete financial ruin.

65 comments :

  1. Dear VP Sir

    Please let me know your view on KSE(Kerala based company)

    Regards

    Sreejith G

    ReplyDelete
  2. Dear VP sir,
    Kindly give your views on Krebs biochem. Is both their units operational?
    Can it turn profitable in f.y 17 !

    ReplyDelete
    Replies
    1. Though there was n income in just concluded FY , expecting profit in FY 2016-17.

      Delete
  3. Sir,

    mindteck is trading almost 50% below the MMB discussed price.
    It is virtually Debt free company, but in quarterly result TAX is showing -6.74 Cr.
    Is it a good buy at this level?
    Please advice.

    ReplyDelete
    Replies
    1. Expecting improvement in performance going forward.

      Delete
  4. Hi VP Sir,
    Since you are not able to give stock suggestions due to SEBI restrictions, can you please give share some stock ideas on MMB on every 2nd Saturday or something like that on regular basis. This will be of great help for us Sir.

    ReplyDelete
    Replies
    1. Don't you know the fate of such efforts ?. Posted messages disappeared on the very next day. In MMB ,lot of boarders interested to attack the person who posted a message instead of criticizing the content of message or propose a different view on it.

      Delete
    2. Sir MMB is too crowded and moderator also against your posts.Then why can't we try others like Economic times groups to share your views...think about it and help people to learn your thought process.
      God bless you VP..

      Delete
    3. Sir with due respect how about GST without publishing the answer. Serious people will only follow and will invest on their own risk. Please sir it helped me a lot to pick lost of other stocks which became gainers. Rakesh

      Delete
    4. Sir, on MMB there are many fake and anonymous accounts. What about Facebook?

      Delete
    5. You can post them on Profile page in MMB. That's your own space and no one can delete it.

      Delete
    6. I agree.. Quite few msgs from VPji are no longer available on MMB... Better to have the quarterly reports of both new and old recos published on this blog.. people can make an informed choice...

      Delete
  5. Hi Sir , As always Nice one . Thanks for sharing

    ReplyDelete
  6. Hi VP sir,
    I understand that you are not able to provide us the stock ideas like before due to SEBI regulations. But is it possible to guide us on how to identify the stocks based on different financial parameters/future growth propect /business model etc and also where/how to start with.
    It will be of great help if you could educate us.

    ReplyDelete
  7. Dear VP Sir, why to post all / any of your comment on MMB when we hav our blog..

    We are waiting old VP Sir to come back again may be with GTS, nobody can stop this !

    ReplyDelete
  8. Dear VP Sir
    Please let me know your view on Enkei Wheels discussed on MMB.I posted this question many times and still waiting for ur reply.Hope this time i will get some update from you.
    Thank you.

    ReplyDelete
    Replies
    1. Still positive on Enkei Wheels ,expecting improvement in performance once global recovery in auto sector.

      Delete
  9. Sir can't we find a platform other than Mmb where messages do not disappear ?

    ReplyDelete
  10. Dear VP sir,
    Kindly give ur views on mangalam drugs, lincoln pharma, hmvl , dtil and pondy oxides. I am holding these stocks. Thanks million.

    ReplyDelete
    Replies
    1. HMVL is an already suggested stock @Rs.187

      Due to some doubt about the corporate governance standard of Lincoln Pharma,as of now not tracking it.

      Delete
  11. Sir, I am holding Godavari Drugs and Orchid Chemical. May I add more in these two stocks?

    ReplyDelete
  12. can i hold geometric share or sell? after this merger news

    ReplyDelete
  13. Sir, your opinion on himachal futuristic communication ltd.

    ReplyDelete
  14. Plz comment to mic electronics..

    ReplyDelete
  15. VP Sir I am big fan of yours.I understand the restrictions implied by SEBI.Despite what peoples wrote after market slide because they are not investors.We have full faith in you sir and your penetrating eyes and constant vigilance is commendable.Sir please express your view on Ujaas Energy.

    ReplyDelete
  16. Sir Can you please share your Views on Sankhya Infotech which you had updated long time back as a stock to watch out for.. Now its trading at discount to peers. Do you still follow it and if yes whats your view on it..Thanks in Advace

    ReplyDelete
    Replies
    1. We have discussed this stock when the promoters of HBL group shown interest in it ,now the situation changed.

      Delete
  17. Hi Sir,

    Can you please share your views on Technocraft Industry,Inox Wind and Surana solar.

    Thanks,
    Shashiraj NK

    ReplyDelete
    Replies
    1. Not tracking first two ., not interested in the last one :)

      Delete
  18. Hi VP Sir, Websol Energy shares were bought by promoters in March 2016. Also saw the news that India Max Investment fund bought shares at Rs.52. Hoping good days started for Websol. Thanks for the recommendation Sir.

    ReplyDelete
  19. Sir your valuable inputs on Nila Infra, Bag Films, next media, Radaan Media, Provogue. Thanks & regards. Hormuz.

    ReplyDelete
  20. Sir, is there no other way to get your valuable suggestions? It is not the matter of few guys but the life of many small investors. My kids are in good school and I'm able to make it only because of you.
    Now I'm like an abandoned child. Looking for the return of the savior.

    ReplyDelete
  21. Sir any comment on Sterling Bio.??

    ReplyDelete
  22. Dear VP ji pls share ur views on Gm breweies, winsome breweries, hotel leela, lake view hotels. Thank u.

    ReplyDelete
  23. Hi VP Sir,

    Whats ur view on Equitas IPO.
    You have Highlighted SATIN at very low level, Do you feel Equitas perform in similar lines with SATIN.

    Also Ujjivan seems to be the Next one to Hit the Market.

    Your Inputs will be highly appreciated.

    ReplyDelete
    Replies
    1. Equitas is a decent one.But once more and more companies from same sector listed ,scarcity premium may come down in future.

      Delete
  24. Sir you had taken my query but it seems it accidentally got deleted
    Kindly share your views on Liberty shoes
    Subtext at current prices looks attractive. What challenges you think the company might face ahead
    Thanks pankaj

    ReplyDelete
    Replies
    1. uncertainty about the business relation with their own group companies is an issue .Earlier they promised some consolidation of various group companies but it got delayed.

      Delete
  25. VP sir what is ur MMB id? how do I search u in MMB board?

    ReplyDelete
    Replies
    1. http://mmb.moneycontrol.com/india/messageboardblog/boarders/76616c75657069636b

      Delete
  26. Dear VP Sir,
    I am holding Galaxy Ent (Rs 31) and United Drilling(Rs 60). What is your current view on these scripts. is it still a hold for long term on both of these stocks. Requesting for your advice.

    ReplyDelete
  27. Hi VP Sir,
    Kindly share your view on Patel airtemp at current price.

    ReplyDelete
    Replies
    1. Decent company,sector revival should happen.

      Delete
  28. Dear Vp Sir, Your view on Insecticides India?

    ReplyDelete
  29. Hello sir, can I know your views on JYOTI RESINS AND ADHESIVE LTD. Company has very aggressive expansion plan and wide distribution network. They boast of having 7000 retail distributors. Sales has also increased 40 crs from 2-3 crs in last five years. Can it be considered as a long term high risk high return bet for long term investor? Please share your priceless thought.. Thanks in advance.

    ReplyDelete
    Replies
    1. I don't know why they are selling product free . Their operating cash flow is negative for past 5 years .No meaning in showing gimmicks to present a picture of improvement in sales ,at the cost of the quality of balance sheet.

      Delete
  30. Dear VP sir, kindly share ur views on mangalam drugs. I am a new follower of you. Thanks...

    ReplyDelete
  31. hi VP sir,
    If you have any views about BDH industries, please share with us. Apparently, this company manufactures a product based on sildenafil citrate.

    Thanks in advance.

    ReplyDelete
  32. Your views on realty sector sir?? Can we expect improvement in years to come?? Thank you sir

    ReplyDelete
    Replies
    1. Not tracking too much companies from this sector ,only Godrej Poperties and Mahindra Gesco.There may be some demand pick up on reduction in interest rate but I am not expecting dramatic improvement in situation if government is serious about anti-black money initiatives.:)

      Delete
  33. Sir can u suggest a good company to invest from Indian defense

    ReplyDelete
    Replies
    1. From an investor point of view , all good companies may not be good investment and the price of asset means a lot .We have discussed few companies from this sector( Centum Electronics..etc ) at lower rate which already turned as multibagger.

      http://value-picks.blogspot.in/2014/11/centum-electronics-ltd-update.html

      Delete
  34. What is your view on persistent systems

    ReplyDelete
  35. Ji pls share your views on bhandari hosier

    ReplyDelete

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