While jumping off from the top of the hill in skydiving may scare the hell out of your friend but excites you a lot. Similarly, while investing, there is a different perspective while taking a risk which leads you to the level of risk tolerance.
When you go to the financial advisor or investment advisor, they suggest a few investments among numerous schemes available in the market, depending on the time horizon, risk appetite, and financial objective.
Everything is done by the advisor to determine your profile, which you can also do by yourself by asking these questions:
Question 1: What is your investment objective?
a. Preservation of capital
b. Income generation
c. Capital growth
d. Speculation
Understanding your risk appetite-
For example, if the preservation of capital is your objective, it can be concluded that you cannot take the risk of losing capital. You can prefer investing in debts or fixed-income securities. Similarly, in the case of capital growth, you can invest in mid or small-cap stocks. While if the goal is speculation, it means your risk appetite is highly aggressive, you can invest in stocks with high volume.
Question 2: What is your investment horizon?
a. Less than 1-year
b. 1-3 years
c. 3-5 years
d. More than 5 years
Understanding your risk appetite-
For example, in the case of a time horizon with less than 1 year, you may invest in debt securities to preserve the capital, as you might not be able to afford to lose the capital invested.
Question 3: What is your investment experience?
a. Have no experience investing
b. I have some experience investing
c. I have significant experience investing
d. I am a professional investor
Understanding your risk appetite-
For example, suppose you are a professional investor. In that case, you might be able to invest in highly aggressive, risky investments, as your understanding of entry and exit in the market, is deep enough to sustain your investment.
Question 4: What is your current financial situation?
a. I have limited assets and income
b. I have some assets and income
c. I have substantial assets and income
d. I have significant assets and income
Understanding your risk appetite-
Suppose your current financial situation is sustainable in any financial crisis, as you have emergency funds to meet the uncertainties, adequate insurance, and retirement funds. In that case, you can invest in high-risk securities. Otherwise, it might be suitable for you to play safe in the market.
Question 5: How would you react to a significant loss in your investments?
a. I would panic and sell immediately
b. I would be very concerned and consider selling
c. I would be uncomfortable but would likely hold on
d. I would be willing to wait and potentially buy more at a lower price
Understanding your risk appetite-
If you panic a lot about losing the capital invested, it might not be suitable for you to invest in risky investments. Choose what gives you peace of mind rather than panic attacks.
Conclusion
Determining risk tolerance level is not only a one-time game to play safe. You risk appetite by the time and personal financial situation. Evaluating and re-evaluating it in a particular interval will help you in giving optimised returns on investments.
Anushka Trivedi is a freelance financial content writer. She can be reached at anushkatrivedi.com
