It is vital to consider your risk appetite while investing
Aug 18, 2012

Author: PersonalFN Content & Research Team

Very often many investors tend hawk on investment products, which offer a higher rate of return and often get lured by the sales pitches given by investment agents / brokers / relationship managers. And while doing so, one of the vital tenets to investing - which is risk appetite, is ignored. Investing, while it may appear to be a simple activity, in our view it’s a serious activity and hence requires enormous amount of insights and discipline to be a smart and successful investor. In the age of knowledge economy, there’s information galore, but you ought to differentiate between information and wisdom, which can lead you to the path of becoming a smart and successful investor.

Through this article we are sure that the ‘investment process' we have outlined herein would help many investors strike the correct chord.

Before we understand the term risk appetite, let us try to understand by what is meant by "risk". To put it simply, risk is a result or outcome which is other than what is / was expected. While you assume risk as an investor, you could either make gains or suffer a loss; thus risk is nothing more than a state of uncertainty, and exists in every facet of life - including investments.

The term "risk appetite" refers to one’s willingness to take risk. But it doesn’t merely end with willingness to make a prudent investment decision; but in fact needs to be backed by a rationale considering risk determinants such as the following:

  • Age:

    Your age plays a vital role to determine your risk appetite. Thus the younger you are, more risk you can take and vice-a-versa. This is because you are in the accumulation or earning stage of your life cycle, where you have more number of working years before you retire. Likewise, if you start investing at an early age the tenure which you get (while investing in an investment avenue) is greater, which enables you to make more aggressive investments and create wealth over the long-term to meet your financial goals.
  • Income:

    Similarly, your income too is an important determinant to gauge your risk appetite. This is because if you income is high enough, you can afford to take high risk and vice-versa.
  • Expenses:

    Your outgoings also influence the risk which you can afford to take while investing. Thus although you may be having a high income, but your disposable income is petite you could be refrained from taking risk.

    We think that in order to keep your financial health in pink in the long-term, it is important that you live within means and curtail your unnecessary expenses. It is this strategy which will enable you save a large portion of your monthly earnings, which can be deployed in suitable asset classes.
  • Nearness to goal:

    Also if your investments are driven by an objective to meet a financial goal, that too would be a determinant for gauging your risk appetite. Thus if you are many years away from the financial goal you could afford to take more risk, while if you are not many years away from the financial goal you could be risk-averse.

Thus ascertaining risk appetite is a combination of these aforementioned factors, and equation of all these can help you test your risk tolerance.

It is noteworthy that while there are investment opportunities and avenues galore, you ought to take care and ensure that you are not cooking a recipe for disasters. As mentioned earlier, while there is information galore on investment avenues you ought to adopt caution and ensure that you are taking a wise investment decision which suits your needs and risk profile. There is no point in being carried away by an investment opportunity which has being hyped (even though it may be really worth it), if does not suit your risk profile. Moreover one should be wary of investment opportunities which harp on returns and does not emphasise on the risk involved. As a matter of fact, in the absence of information related to risk, information isn't just incomplete, it's downright misleading.

So the next time you hear or read of investment opportunities and avenues ask yourself a simple question - "Does this investment opportunity or avenue suit my risk profile, although it may deliver luring returns?" Remember, investing is not about how much return you like, but how much returns you can safely handle.

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