By defining risk appetite, an investor can arrive at an appropriate balance between uncontrolled risk taking and excessive caution
Risk appetite or one's risk-taking ability is a key consideration before one picks an asset class to invest. It is defined as 'the amount and type of risk that an individual is willing to take in order to meet their return goals. Knowing your risk appetite can help ensure that you buy a product that is most appropriate for you and your requirements. But the question is, how does one measure his risk appetite? Precise measurement is not always possible and often risk appetite is defined by a broad statement of approach.
By defining risk appetite, an investor can arrive at an appropriate balance between uncontrolled risk taking and excessive caution. It can guide one on the level of risk permitted or possible and encourage consistency of approach.
To evaluate your risk appetite, you need to look at various aspects such as life stage or age, what you own and what you plan to own, your experience with various investment products and instruments and then your investment horizon, among others.
Age is of course the most crucial factor. The younger you are, the more risk you can take, A younger person has lesser responsibility and financial burden on his shoulder and hence can afford to take higher risk, be it with career choices, investment or be it with enterprise.
Plus at a younger age, you are better positioned with your income flow as you have better choices with regard to jobs and you can afford to accept a financial setback more easily. Moreover, it is most likely that you will have fewer dependents to take care of, which allows you more flexibility with your money.
Your risk-taking ability is also dependant on what financial cushion you have. If you are entirely dependant on a specific fund corpus, you will have less flexibility to play with that money. So your asset ownership is important here. If you already own a house or have sufficient deposits in a safe bank FD, you would feel freeer to invest your ready cash in a more risky asset class.
Experience is what makes you a good investor. Your knowledge about investments and understanding of various products will prepare you better to decide on product or an asset class and approach it in a more matured way. People with prior experience in investing in financial markets understand the long-term impact of short-term fluctuations in the market, hence, can take more risk.
How long you have stay invested in a particular product is what is called you investment horizon and this an important factor in evaluating your risk appetite. Your investment horizon is linked to your financial goal. If what you have in mind is a long-term goal, you can opt for a risky portfolio with high returns, as the risk would reduce over time. .