If you visit any of the financial advisors, they would ask you about your investment objective, which will help them understand the duration linked to your financial goals, and as the conversation unfolds, he would try to understand your risk appetite besides your income status, financial and family background.
Now, the question is, why is this assessment important?
Recently, if you have observed, you must have seen a lot of new-age investors flocking to the Equity Market, and some are taking a step ahead and are investing in cryptos before investing in any product. One must know the risk and rewards associated with it, but often we skip this part. So, is this the right way to invest, or is our mind hijacked by the quick rich scheme bombarded by the Instagram pages and YouTube influencers lecturing us on how easy the financial market is?
I believe that information should be accessible and available to everyone. Unfortunately, not everyone is on the same level playing field. Everyone doesn’t have the same set of information and a similar level of skills to understand and interpret the complexities of the market. And then there are people behind the curtains who run the show and adding to that, we have also witnessed scams perpetuated by digital thieves with a coded knife.
Before understanding any financial product, one must understand their financial status and their state of mind; as an investment is not only the exchange of money from your pocket to someone else’s purse, investment is a decision linked to your life, every major and minor event that you will eventually encounter which involves financial decisions will have an impact on the money decisions that you made in the past.
Said so, let’s understand ‘Risk Appetite’, as this is one of the key factors to your investment decision.
Risk appetite refers to the ability, willingness, and psychological capacity to take the risk. Different individuals have different levels of risk-taking capacity.
If you ask a salaried person, he would want a stable life. On the contrary, a business person might be willing to trade an extra risk for higher gains. An old man, in his late 50’s wishes to spend the rest of his life in peace, gardening and sipping a cup of tea with his beloved wife, rather than brewing heartaches by the volatility of the market. Similarly, if you suggest a man/woman at his prime, who wants to own a house after 10 years to invest in Bank FD’s, it would be a grave injustice.
To understand your Risk Profile you can take a risk assessment test, and you will be assigned any of the following profiles:
- Very Aggressive: These investors aspire to outperform the markets by a substantial margin, and they are taking on significantly more risk than the markets. Their portfolio majorly consists of growth, small-cap, and sector mutual funds. Any fixed-income mutual funds that are included in the portfolio will be of riskier types and those that are generally aggressively managed. The purpose of any cash held is to handle any unexpected withdrawals and to take advantage of perceived buying opportunities.
- Aggressive: An investor in this category wants to outperform the market when the markets are up and doesn’t mind too much, being down a little more than the markets when they are down. Fixed income positions are minimized, and risky asset classes are fully utilized. The portfolio is aggressively-managed. These investors want to take the risks of winning the game by playing hard offense but still don’t want to lose too much in a short period.
- Moderate: The majority of investors fall in this category. These investors generally have a long-term goal either for retirement or funding for children’s education & marriage expenses. These investors are looking for high profits and are aware that they will have to take certain risks to get them. Their portfolio would gain less or equal to that of the market at the time of rising and fall less when the market falls. A Moderate portfolio will hold a balanced mix of all-major viable asset classes (for maximum diversification).To limit risk and improve revenues, both safe and risky asset classes are employed to their full potential.
- Conservative: The investor in this category can tolerate a little more risk than the highly conservative investors. They are averse to large short-term downside fluctuations and are happy with little more return with a little less income. The average investor in this category is either retired and earning a living from their investments or is about to retire. These folks want to be shielded against significant market downturns, also they’re not willing to fully participate in upward market rallies.
- Highly conservative: This investor desires to be protected from “noticeable downside market fluctuations” and will forsake almost all considerable upside possibilities relative to the markets to attain their goal. Often these investors want an inflation-adjusted stream of income from their holdings to cover their living needs. Investors are afraid of losing what little money they have left. They don’t have time to make up for any lost ground. The majority of their money should be held in liquid and high-quality Debt Mutual Funds, risky asset classes are typically avoided altogether.
When you have identified your “Risk Profiles”, you are halfway ready for your investment journey. You can also take a risk assessment test by downloading the MyGoalMySip app.
Written by: Arup Kr. Mondal
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