Determining how much loss of money you can handle to gain excess returns is a difficult yet crucial task of investment management. When you go to any investment advisor, the very first thing they will evaluate is the capacity of risk of losing the money you can take. Many times you may consider risk-appetite as an emotional factor. However, it depends on several quantifiable factors as well.
Let's understand quantifiable factors of investing, or we can say crucial aspects of investing which exclusively determine your risk appetite. These are as follows-
Return on investment
The potential return on investment is a major factor that affects an individual's risk appetite. Higher potential returns often come with higher risks, and some people may be willing to accept higher risks in exchange for potentially higher returns. The desired rate of return on investment is the factor that impacts risk appetite for sure.
For example, If your risk appetite is moderate, and you still want to invest in the stock to gain returns, you can go for large-cap funds instead of mid-cap or small-cap ones.
READ MORE: How to determine risk appetite? Here are 5 steps
The length of time an investor plans to hold an investment can also affect their risk appetite. Those with a longer time horizon may be more willing to take on riskier investments because they have more time to weather any short-term fluctuations in the market. Time horizon plays a crucial role in determining risk appetite.
If you are looking forward to investing long-term, you might be able to take more risk as compared to mid-term or short-term financial goals.
An individual's current financial situation, such as income, expenses, and debt, can also affect their risk appetite. Those who have more disposable income and fewer financial obligations may be more willing to take on riskier investments. Also, current financial stability plays an important role in defining risk tolerance levels.
For example, if you have adequate emergency funds, insurance cover for you and your family, and investment for retirement, taking more risk might be an option to get better returns on your investments.
READ MORE: Flexi cap or multi cap funds: What should investors choose based on their risk appetite?
Investment knowledge and experience
An investor's knowledge and experience in the financial markets can also play a role in their risk appetite. Those who are more knowledgeable and experienced may be more willing to take on riskier investments because they have a better understanding of how the markets work.
Knowledge gives confidence about the industry you are investing in, which helps in predicting according to the prevailing market conditions. The more knowledge you have, the more likely you are to take risks.
Personal attitudes and beliefs
Finally, an individual's personal attitudes and beliefs can also influence their risk appetite. For example, someone who values financial security and stability may be less willing to take on risky investments, while someone who is more comfortable with uncertainty and volatility may be more willing to take on risk.
Overall, the risk-tolerance level does not depend solely on qualitative factors such as emotional attachment to money, but it majorly depends on quantitative factors. Additionally, quantitative analysis of personal finance helps you make more informed decisions rather than emotion-led decisions, which might lead you to miss out on opportunities to gain returns.
Anushka Trivedi is a freelance financial content writer. She can be reached at anushkatrivedi.com