What determines a retail investor’s risk appetite? Find out

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November 08, 2021 3:51 PM

Almost all investment products are exposed to various risks, only the degree differs. Therefore, it is very important to understand the risk appetite before investing in any kind of asset.

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Before the US 2008 crisis, many were sure that it was stupid to think the housing market was a bubble because every major bank and investment firm seemed to be doing just fine until things went south. Only some financial analysts could see it was a bubble, which was going to burst soon.

Anshul Gupta, Co-Founder at WintWealth, says, “The lesson from the 2008 crisis is that we don’t know what holds in the future; that’s what makes it risky – One’s ability to take high or low risks entirely depends on the individual’s situations, goals and, more importantly, where he/she comes from. That’s what risk appetite is.”

For instance, Ravi has lived in an environment where his peers have taken risky bets and lost their money. He naturally will likely have a low-risk appetite because Ravi has seen what people face when they take high risks and lose out. On the other hand, if Anoushka, an investor, who have taken big bets and made money almost every time, will tend to have a high-risk appetite because of her experiences.

“Your experiences in life will determine your risk appetite better than any other factor ever will,” says Gupta.

Note that, almost all investment products are exposed to various risks, only the degree differs. Therefore, it is very important to understand the risk appetite before investing in any kind of asset.

Often, experts say when talking about risks, people tend to confuse between risk tolerance and risk appetite. Risk appetite refers to one’s willingness to take risks, while risk tolerance implies one’s ability to do so.

Here are some of the factors that determine one’s risk appetite:

  • Age: The risk appetite tends to reduce over time as you age because as you grow older everyone tends to look for stability and not for high volatility. Whereas, experts say someone who is young can take high risks because of ample amount of time to recover from any losses and long line of working years.
  • Past experience: According to Gupta, an investor past experience plays a huge role in determining their risk appetite. For instance, if you have invested in an asset that has given you sufficient returns and is a good investment overall, you are likely to take more risk on that asset even if it is not giving good returns recently.
  • Wisdom: An asset like this, Gupta says “is valued more than any investment in your portfolio. If you have the wisdom and knowledge to understand and use it the right way, it will increase your awareness.”

Having said that, with the help of good investment processes and the right asset allocation, you can optimise your returns with a relatively low level of risk.

Additionally, before starting to make investments or if you have already made some investments, experts say one should ensure to get the basics right.

1) Emergency Fund (3-12 months): It is a fund that you can fall back on in case of any unexpected circumstances. Note that this fund is not for your regular expenses.

2) Term Insurance: Death is an unfortunate event and at times like this financial burden has to be borne by the family. Gupta says, “To prevent such a situation from arising, it is a good idea to invest in a term plan that would take care of the financial needs of the family.”

3) Health Insurance: This provides financial protection in case you or your family members have a serious accident or illness. If you have this in place you don’t have to dive into your retirement funds or emergency funds to pay the expenses.

It is crucial to take note of certain things first before making long term investments as Gupta says “securing yourself against the uncertainties of life will cool off your financial burden in the long term.”

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