The phrase “No pain, no gain” is very relatable when it comes to the risk return relationship. It is simple to understand that higher risk means higher returns and vice versa and this is true now than ever before. Under the present conditions, one thing is very certain, there are no freebies. Every gain comes at a price and the same applies to the return on our investments.
People generally jump into schemes or funds offering super normal returns without understanding the risk factors associated with them and without the capacity to digest the fluctuations. The result? Another investor rolling in their tears cursing the market.
But why do situations like this arise? Why do people drop so much money into funds that don’t fit them? Greed? Probably Yes, but most importantly it is investor education… it is important to always understand the investment trio i.e. risk, return and time frame and neglecting any of these lead to unfavorable financial effects.
Just because your friend or colleague is investing or experimenting in equity and is doing well doesn’t mean even you have to. Every investor is unique with unique characteristics, ability, income, risk appetite and goals.
RISK Appetite, something not many lend an ear to… but has the power to determine and change the course of investments. Every individual displays very different tendencies to risk and that is what is risk assessment. It just doesn’t talk about the risk one can stomach but also their willingness to take that risk and this is the reason, RISK TOLERANCE IS PERSONAL.
Here are few factors determining one’s risk profile and why it varies with every individual:
1. Income: When we talk about income determining the risk profile, it is the disposable income we are referring to. This means the money that is not reserved or kept aside for anything and are open to be invested and risked as well. So when disposable income is high, the risk appetite can also be high.
2. Knowledge is power: The asset which never loses value! That’s right knowledge and experience of the markets contribute significantly to the risk appetite. The knowledge of the various products and the basic know how of how markets work is something that will help in analysing and investing perfectly based on one’s situation.
3. Financial Responsibilities: With great financial responsibilities comes lesser risk appetite. The financial responsibilities take the front seat in the priority list and any money needed to fulfill these responsibilities is not something one has to fiddle with. The stories of “erosion of funds saved for daughter’s marriage or son’s education” has not taught enough lessons to people and they continue to be lured by higher returns. So it is a strict NO NO to make riskier investments when one is burdened with financial responsibilities.
4. Age: We are not 21 forever and that is a boon as well as a bane. These early years of investing has to be made the best use of…We certainly cannot ride the market fluctuations wave in our 80’s like we can in our 20's and 30’s and this is primarily because as the investors mature in age and reaches retirement, they psychologically cannot tolerate high volatility in their portfolio. Any dip in investment value will lead to erosion of the retirement corpus. On the other hand, young investors can comparatively take higher risks as they have a longer time frame of working years before retirement. They have ample amount of time and opportunities to recover from any possible setbacks in the value of the portfolio. The bottom line - the investors risk appetite generally declines with age.
5. Comfort Zone: Everyone wants to stay within the safe circle in life, but when it comes to investing some are quite conservative while some are daring to take more risks and still be comfortable with it. This nature of risk taking comes naturally and they don’t have to be labelled as foolish. They have a higher willingness to take risk and if it is coupled with the ability as well then they can take high risk and build a comparatively riskier portfolio.
The risk assessment generally categorizes you into either one of the categories namely: High risk, moderately high risk, moderate risk, moderately low risk or low risk appetite. They can be expressed in different word forms by different advisors. And these assessments help you determine the kind of investments that suit you the most.
Have you ever thought what your risk appetite might be? There are many questionnaires available online to know this, but we recommend you to assess your risk profile by signing up on www.7prosper.com and guess what…
You can generate a custom goal based financial plan based on your risk profile.
What factors have influenced your risk appetite? Let us know if we have missed out on any in the comments section.
Image Credits Business vector created by dooder
