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Money hungry: How to evaluate your investment risk appetite


Rahul Jain* says your risk appetite denotes the magnitude of risk you are prepared to stomach based on your investment goals and expected returns.


 

When we start our investment journey, along with the anticipation of returns, one of the first things we evaluate is our risk appetite.

Risk appetite denotes the magnitude of risk an investor can stomach based on their goals and expected returns.

But justifying your risk can often leave you confused.

The easiest way to come to a solution is to ask the right question.

How vital is your investable surplus?

This is the first question you need to answer while gauging your risk appetite.

The value of money or rather an investable surplus plays a critical role in shaping your risk-taking potential.

If you have an investible surplus of say $400,000, a loss of $2,000 to $4,000 due to vagaries of the market may not affect your financial health and goals much.

On the other hand, losing this money from a surplus of $10,000 may derail your finances and force you to compromise on your life goals.

Thus, the worth of money goes a long way in the development of risk appetite.

You can adopt an aggressive approach with a higher surplus and vice-versa.

Financial goals — and the way forward

Financial goals are time-bound objectives, which are generally classified into three buckets — short-term, medium-term and long-term.

While short-term goals may entail going on a vacation or buying a car, objectives such as providing higher education for your children fall under the category of medium-term.

On the other hand, retirement is a long-term goal.

However, it’s important to note that not all goals are negotiable.

For example, you cannot compromise or delay the higher education of your children.

On the other hand, going on a vacation or purchasing a car can wait for some years.

On most occasions, you would not like to take unwanted risks with your non-negotiable goals.

For negotiable goals, you can take some amount of risk and make high-risk financial investments.

Maturity in stock markets

Everyone evolves in the stock market at a different pace and this contributes to different experiences for each individual.

For instance, you may have made a capital investment at a time when the market was firing on all cylinders, thus enhancing your gains.

This may build up a higher risk appetite.

Or you might have entered the market when it was going through a rough patch, resulting in losses.

This experience can lead you to tone down your risk-taking potential.

In other words, the level of comfort with markets drives your thinking process and subsequently investment strategies.

The takeaway

Every investor is unique in term of cash flow and liabilities.

This uniqueness makes risk-tolerance levels distinct for each one of us.

However, to achieve financial freedom, it’s crucial to have a fair estimate of your risk appetite.

 

Rahul Jain is Head of Personal Wealth Advisory at Edelweiss Wealth Management.

This article first appeared at www.moneycontrol.com/news