By Bharat Phatak
Identifying risk tolerance level is crucial for creating a retirement investment strategy that aligns with one’s financial goals, preferences, and overall comfort level with risk. By assessing it, you can undertake efficient asset allocation for your investment portfolio.
Risk tolerance
Risk tolerance refers to one’s ability and willingness to handle uncertainty and potential losses while pursuing investment returns. This assessment varies based on psychological, emotional, and financial factors that shape your comfort with taking risks.
There are several factors to consider when evaluating risk tolerance for asset allocation in retirement. The first one is age. Those in their 20s and 30s have higher risk tolerance due to more time to recover from losses. Those in their 50s or nearing retirement tend to have lower risk tolerance. Higher-income individuals have higher risk tolerance due to greater financial resilience. To conduct a personal risk assessment, reflect on your existing financial situation, focusing on capital preservation, income stability, family responsibilities, and long-term growth preferences. Consider the time horizon to know the level of risk you can afford.
Asset allocation
Different asset allocation strategies should be employed to match individual retirement goals and risk tolerance levels for different categories of investors.
Conservative allocation: This strategy focuses on capital preservation and income stability. It involves a higher allocation to fixed-income investments with a smaller portion allocated to equities. For those in their late 50s or nearing retirement, the ideal asset allocation would be 60% in fixed-income instruments, 10% in liquid assets or precious metals, and 20% in equity.
Balanced allocation: The balanced allocation strategy aims to strike a balance between capital preservation and growth. This approach is suitable for individuals with a medium risk tolerance seeking a mix of growth potential and risk mitigation. Investors can choose to opt for an asset allocation of 50% fixed income, 40% equities, and 10% cash equivalents or precious/alternative instruments.
Aggressive allocation: The aggressive allocation strategy focuses on maximising long-term growth potential. This approach is suitable for individuals at a younger age. The asset allocation can be 70% in equities, 25% fixed income, and 5% cash equivalents to capitalise on growth opportunities.
While undertaking retirement planning, it is crucial to implement systematic withdrawal plans which allows you to withdraw a predetermined amount from your retirement corpus at regular intervals to meet your income needs while also providing compounding benefits for the remaining funds.
Handling Uncertainty
*To conduct a personal risk assessment, reflect on your existing financial situation, income stability, family responsibilities & long-term growth choices
* Consider the time horizon to know the level of risk you can afford
The writer is director, Scripbox