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Risk appetite and Risk tolerance: How important are these in investment decision making?
Generally speaking, it determines the extent to which an investor is willing to or can tolerate high order changes in the value of his or her investment. So, investors either based on their own financial understanding or through financial experts and advisors (risk profiling) need to assess their appetite for risk.
The capital market regulator SEBI also made it mandatory for investment advisors to profile their clients and for that a questionnaire provided needs to be filled by the prospective investor. Based on the input, financial advisor ascertains your risk appetite and suggest investment products that are most suitable for you.
Based on the criteria, 2 categories of investor class are mainly known risk-averse or conservative investors who take minimal exposure in risky investments while the other class is of aggressive investors who do not hesitate from taking high risk for high returns.
So, few of the considerations or factors that can help you determine your risk appetite in the investment science are as follows:
a) Investment horizon: Risk tolerance level can be ascertained on the basis of your age and available investment time horizon for realizing a particular financial goal. In case you are young, you have a longer time frame to bet on an investment product in contrast to someone who is relatively old or reaching his sunset years, so a higher risk tolerance level for you cannot be negated.
b) Net worth or financial position: HNIs can assume higher risk in comparison to other investors. It is to be remembered that one should put only that amount or quantum of capital at risk in an investment or for trading that shall not affect his/her lifestyle in case the amount is lost.
c) Knowledge and experience in respect of specific investment product: In case you hold a good experience in investing in a particular investment basket and have a made substantial gains in the prior period, you'll be further tempted to take a higher risk for far-better gains.
d) Other parameters: Financial responsibilities at hand, current financial position, personality of the concern also come into play when deciding on the risk tolerance level.
So, after careful and diligent assessment of your risk appetite and tolerance level, you can decide on your investment strategy to achieve your long-term financial and investment goals.
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