What is risk appetite?Be it investments or savings, both entail a mix of risks, including:
- Default risk- Risk emanating from the fear that an institution would fail
- Inflation risk- Risk emanating from the concern that money would not cope with increasing prices
- Volatility risk- Risk stemming from the fact that stock prices can fluctuate any time
- Interest-rate risk- Risk emanating from the belief that you could’ve got more hefty returns through an alternative mode of investment
The idea here is to strike an equilibrium between these types of risks. However, what could be a good balance for you might not be all that good for your peers. This essentially implies that your stomach for risks is likely to be different from that of your peers.
Your risk appetite rests on:
- Your comfort level with risks
- Your personal investment goals and objectives, the time frame within which you’d ideally want to reach your goals, and your need for returns
- How much you can afford to lose
The combine of these three determinants is what forms your risk appetite.
How do you assess your risk appetite?Stated below are some of the more important factors that go into determining your stomach for risks:
AgeAge is certainly the most crucial component of your risk profile. Stated simply, the younger you are, riskier the investment decisions that you can take. Should the economy spiral into a downturn, you would be better abled to wait the period out till the point in time markets bounce back and investments gather speed yet again.
According to financial experts, equity allocation should be ideally 100 minus your current age. While this can serve to be a helpful guideline, it has its flaws as well. Considering you are 25, it doesn’t mean that you can go ahead with a 75% equity exposure. A mix of other factors contribute here as well.
IncomeA lump sum income affects your risk profile differently, considering minor setbacks wouldn’t affect your portfolio or your ability to invest, for that matter. While self-employed professionals don’t really have a definite income to fall back on every month, their salaried counterparts – owing to more regularized pay-checks – can afford to invest in avenues with short-term volatility but also marked by the ability to deliver superior returns in the long run.
Financial liabilitiesShould you have a mortgage or other financial liabilities – children’s education or marriage, for instance -- to shoulder, it is advisable that you avoid investments that entail a higher degree of volatility. Remember that payments towards debt should ideally not exceed 40-50% of your income.
Conversely, should you not be shouldering any type of financial obligation, you can then move ahead with increasing the risk exposure of your portfolio.
Number of dependentsShould you have a number of dependents relying actively on your source of income, try and limit risky investments. On the other hand, should your spouse be working, and you have no dependents to attend to, you can then afford to expand your scope of risks.
Time remaining to achieve the goalThe time frame for your financial goals should be a crucial determinant of your risk appetite. Considering you are still a considerable period of time away from realizing your investment objectives, you can afford to take riskier investment decisions in order to generate superior returns over a shorter period of time.
That being said, with financial goals drawing nearer, you should ideally keep off exposing your portfolio to volatility in an attempt to prevent erosion of wealth.
In conclusion, you can align investment-related risks with your risk appetite by making a large spread across a wide range of investment avenues.
The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information
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