As you see the Sensex racing towards the 4000-mark, you realise suddenly that you need to be a part of the action. You must invest in shares.
But wait! Shares can bring you big returns and also help you lose your shirt.
The key to deciding whether or not you should invest in shares -- and how much -- depends on your ability to carry on life when you lose your shirt.
So the basic thumb-rule is: you can afford to bet as big as you can afford to lose.
But if you need greater clarity, you need to understand your risk-quotient. Are you risk-averse, risk-friendly or risk-neutral, or somewhere in between? Here are a few tips to find out:
Age: Generally speaking, younger people can -- and should -- take greater risks. As you grow older, you should be enjoying the benefits.
Says Sachin Shah, assistant vice-president, Equities Advisory Group, Motilal Oswal Securities: "We ideally recommend a 100 minus age allocation for equity in the entire portfolio."
That is, if your age is 30, then 70 per cent of the portfolio should be in equity. The allotment towards equity should reduce with the increase in age, as one's risk appetite goes down. No need to follow this exact formula, but you get the general drift.
Personal status: If you are married, you take fewer risks, if you have dependents, young children and old parents, then too you take fewer risks.
You need to re-evaluate this situation if the children leave the nest for their own jobs, or parents are no longer around.
Career status: At what stage of your career are you? If you are at the peak, and retirement is more than ten years away, you can afford to take risks.
If retirement is just a year away, you put more debt in your portfolio and less equity. In case you have just begun your career, your risk-taking ability is reasonably high as you are expecting funds to flow in.
Tenure: A lot depends on how long you want to invest. If your investment horizon is a few months, equity is not a great idea -- unless you believe you are a stock market pro.
"The tenure of investment will determine your risk appetite to a fair extent," explains Sameer Kamdar, national head, mutual funds, Mata Securities.
"If you want to invest for three months, an equity-based allocation will involve a high risk, whereas over the long term, equities outperform debt-based funds," he adds.
Saving ratio: Your monthly ability to save also determines how much risk you can take. Shashi Nambiar, vice-president, sales & distribution, Prudential ICICI, says that the "proportion of your monthly income you are investing (automatically) allocates your risk to an extent. If you are saving a very small percentage of your income and investing it, it is not advisable to adopt an aggressive approach." That means avoid too much equity.
Financial back-up: If you have a financial nest-egg or a rich godfather, it assists your risk-taking capacities. Another consideration should be your current standard of life.
If you already own your accommodation, a vehicle, and take frequent holidays abroad, your risk appetite is higher as your requirements are well above the 'basic necessities.'
Expectations: If you want higher gains, you must be willing to lose more too. Ask yourself: if your portfolio gains handsomely next month, will you invest more or book your profits?
If you have answered book profits, you probably have less of a risk-appetite than you think. "The element of rebalancing of one's asset allocation often is the key to evaluation of one's risk profile," says Nambiar.
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