Risk appetite is one of the first and foremost things an investor must consider before parking his/her hard-earned money in an investment avenue like stocks, PPF, NPS, fixed deposits, and mutual funds, among others.
While talking to a financial planner or reading a story on investment and personal finance, you must have heard or read this common advice – “Determine your risk appetite before investing.” However, have you ever wondered – what is ‘risk appetite’ and how to evaluate it?
Simply put, risk appetite is defined as the amount of risk an organization or individual is willing to accept based on their goals and expected returns. Risk appetite, therefore, is one of the first and foremost things an investor must consider before parking his/her hard-earned money in an investment avenue like stocks, PPF, NPS, fixed deposits, and mutual funds, among others. Doing so will help you measure the magnitude of risk based on your goals and expected returns.
So, let’s check out how we can evaluate our risk-taking capacity:
1. Investible surplus
A higher surplus, say Rs 1 crore, denotes that you can take bigger risks without worrying about small losses. For instance, if you face a loss of Rs 1-2 lakh due to market fluctuations while you have a surplus of Rs 1 crore, it may not bother you at all. However, “it may significantly affect your financial health and goals if you bear the same loss with an investible surplus of Rs 5 lakh. So, you may follow an aggressive approach when you have a higher surplus, but you should slow down a bit when you are investing with less capital,” says Anuj Kacker, Co-Founder, MoneyTap.
2. Negotiate goals
Financial goals are classified into three categories: short-term, medium-term and long-term. Short-term goals may include travel plans or buying a laptop or car, medium-term may entail children’s higher education and marriage, and long-term goals mostly speak of retirement plans.
For instance, how one can continue earning money just like a monthly salary by making right investment decisions. But goals may change with time. While you can negotiate some of your goals like postponing your travel plans, you can’t compromise on others such as children’s education. The takeaway is, take some amount of risk with your negotiable goals, and keep all your non-negotiable goals out of the risk radar.
3. Market conditions
You may have invested your money when the market was going through a rough patch and hence faced losses. In this case, you must lower down your risk-taking potential. “In contrast, you would earn huge profits if you invest in the market when it is performing well. This enables you to take bigger risks. Simply put, you must build your investment strategies in line with the current condition of the market to avoid losses at least,” says Kacker.
4. Learn from your reactions
Another way of measuring your risk appetite is to go through various questionnaires available online. For instance, when you read a question like what would you do if your long-term investment goes down by 40% within a year. If this situation worries you a lot, it means you have low risk-taking potential. On the other hand, if you accept the loss, move past it, and decide to continue investing, it’s a clear indication of a high-risk appetite.
5. Get a financial advisor
If you are confused or not prepared well to take your investment decisions by yourself – which is quite normal, especially for the first-time investors – it’s wiser to go to a financial advisor and get all your goals sorted. “A good advisor can handhold you in picking the right class of assets that can give you better returns and in fact also help you learn the techniques to excel in your investment journey. Slowly but surely, you will learn the rules and how to win this game with patience and mindfulness,” advises Kacker.