Factors that decide your risk appetite

Hiren Dhakan
Bonanza Portfolio

It’s a known fact that higher returns on investments come only along with commensurate quantum of risk; the greater the risk, the greater the return and vice versa. However we know that while everyone needs highest possible return on their investments, its everyone cannot afford or are capable to take the risk needed to earn that return. So how do we decide how much risk we can take or what all factors can contribute to decide the financial risk we can take?

Knowledge & Experience:

Knowledge and experience about investing helps a lot when choosing the right investments, choosing when to invest and when to exit. When you fully know about the instrument you are investing into, you essentially have your own reasons to invest and you understand how much risky the instrument is. You understand what all factors can pose risk to your investments and you know when is the best time to exit when you feel the investments are getting out of your control. With experience you may know where to invest and where not, and whats the degree of risk in a particular investment.

Savings, Goals & Liabilities

We all have incomes and expenses, a house-hold budget and savings. After deducting our living expenses from our income, we usually save the rest into various saving instruments. It could be savings account, FDs, bonds or even equity shares. We save and investing to fulfill our life goals may it be a retirement, vacation, children’s marriage or higher studies etc. We know how much we need to accumulate and upto what extent that amount is flexible. If your savings regularly exceeds the minimum amount required every month to be invested to meet a particular goal, you will have some leeway to take risk, but what if, for the time, your savings are not enough to accumulate for that goal? You will be bound to invest only in instruments that that provide capital protection and a guaranteed fixed return i.e. a zero risk investment. Your risk appetite would also be sub-dued by the degree of liabilities you own. If a higher proportion of your salary goes towards EMI, with limited savings, your investments have to be directed towards only safe investments.

Age

The time till your goal also decides your risk appetite. If you are young enough, say a bachelor and do not have any family responsibilities, with all your income in your hands, you are best placed to take calculated risk and earn higher returns. Usually the preferred asset classes would be property, equity shares, equity mutual funds and other market linked instruments. This is because you have plenty of time to give to your life goals. Even if some investments go wrong, you can take corrective measures or there’s even a chance that your investment recovers on itself over the time. However if your family is dependent on your income, your are sole earning member of your family, you have to make sure that your life goals are not missed due to unexpected investment performance. If you are independent retired couple or are close to retirement, you will not prefer any kind of risk as you know that your income cash inflows would stop and your only income would be what your investments earn for you. In such cases investors usually choose investments with least risk and fixed cash flows like FDs, PPF, recurring deposits, endowment plans of life insurance companies and liquid mutual funds.

These are the prime factors that shape up the risk profile of most investors but there can be several other factors which may differ along with one’s family background, financial stability and life goals. Every investor does have a fair idea about one’s life goals, liabilities and the time they can give to their investments. However, there are situations when one is financially stable but does not have much knowledge about investing nor the experience to choose the right product. In such cases its always prudent to consult a qualified financial planner who may analyze your personal and financial profile and plan your investments accordingly.