What’s your risk appetite and risk tolerance?
Risk appetite simply refers to how much risk one is willing to accept. Risk tolerance indicates how much risk our finances can actually handle. The two might be very different.
Example:
Mr. Arka Roy is a young man, married with a child. His risk appetite may be high. This may be based on his investing tendencies, in case he has done well with equity in the past he is confident to do well in the future also and hence has a high appetite for risk.
However, based on his financial situation which comprises factors such as the level of emergency fund he maintains, if he has any loan EMIs that are chipping away at his income and so on, his risk tolerance might be very low indeed.
You should assess your own risk profile to know where you stand compared to your own risk appetite and risk tolerance.
Risk profiling is an exercise to determine how much risk is appropriate for an investor.
Risk profile is subjective. Few persons have the ability or objectivity to determine their risk profile appropriately. This is done by asking several questions as part of a structured data gathering exercise. Examples of few such questions are:
What is your age?
A young investor will have a higher risk taking capability than older person due to sheet fact that he has more time on his side
How many earning members are there in the family?
If the number of earning members are high then risk taking capacity goes up but if there is only one earning member then he can have lower risk taking capacity.
How many dependent members are there in the family?
How stable are the income streams in the family?
If the job is a permanent full-time one as compared to a freelance consultant then the person will be having a higher risk taking capacity .
What is the level of the investor’s current wealth, in relation to the fund requirement for
various needs?
Already if the investor has gathered substantial asset then he can take on higher risk,
What is the liability and loan servicing requirement of the client?
If the investor has single or multiple loan EMI running then a major portion of income gets eaten up by such liabilities leaving little surplus for investing and taking risk.
If the market were to fall down by 10%, how will you respond?
The investor who believes in increasing his position when the market falls is obviously comfortable with risk and losses. If a market fall were to trigger an exit from the investment with whatever can be recovered, then the investor is not a candidate for risky approaches to investment.
Such questions help in understanding the psyche of the investor and accordingly asset allocation is customized for the investor.
