If you approach any financial advisor/planner for advice on where to invest your money, one of the first questions posed by them would be if you are comfortable investing in riskier avenues for better appreciation of your wealth. Some of the well established financial planning outfits would also have you fill up a risk profiling questionnaire asking questions like how would you react if you lose money on your investments etc. to find out how much risk you would be willing to take in order to get better returns on your investments. In other words, they are trying to understand your risk appetite.
As we all know, risk and return and directly co-related. Higher the risk, higher the return.
While the professional risk profilers in the market try and assess your ability to assume risks, each one of us has to be aware that there is a difference between the amount of risk we are willing to take and the amount of risk we ought to take. For eg.- A young man in his early twenties who is conservative may want to just park all his money in fixed deposits, but that would mean that his savings would not be able to even beat inflation let alone fetch decent returns. Likewise, a 70 year old retired man may be attracted to stock market trading and may not mind staking a significant portion of his monthly pension to it, but a long term consistent downtrend in the equity market could render him penniless to the extent that he may not even have enough for his basic sustenance!
So, how do you decide what is the optimum risk you should assume? Though there are no established rules to determine this, the following are some of the factors which largely determine your risk appetite.
|Number of earning members in the family||More the no. of earning members, more is the risk appetite|
|Life expectancy||Longer the life expectancy, higher the risk appetite|
|Age||Lower the age, more is the risk which can be assumed|
|Job Profile||People in high risk jobs should assume lesser risks on their investments|
|Income profile||People with regular income streams can take more risks compared to people with unpredictable or irregular income|
|Existing assets/net worth||Higher the current net worth or capital base, higher the ability to face the downside risk|
|Your psyche||Sportsmen and people who love adventure have a better mental make-up to accept any losses which come with the risk, hence they have a better risk appetite|