There is no doubt that every investment comes with a certain degree of risk of default. Therefore, investors should always consider the amount of risk they are comfortable with or can tolerate when investing in any asset class.
Simply put, it is the amount of money an investor is comfortable to lose when making an investment. Therefore, anyone willing to lose only a small part of their investment has a lower risk tolerance, while anyone open to losing a larger amount of their investment in the hope of higher gains has a high appetite for risk.
Understanding one's risk tolerance is vital when looking to invest or plan an investment portfolio. For instance, people with a low appetite for risk often settle on less volatile investments.
Investors are broadly classified into three categories based on their investment strategies, determined by their risk tolerance levels.
These are investors with a high-risk tolerance and are likely to be well-versed in the market and, therefore, ready to take greater risks. Such investors are usually unperturbed by negative changes in their portfolio, either due to a higher safety net or the ability to sustain investment for a longer period of time in anticipation of eventual returns. While larger amounts of risk create the possibility of large returns as well, such investors also stand a high chance of losing all or significant parts of their capital.
These are investors that resort to moderate investment strategies. They are less risk tolerant compared to aggressive investors. Therefore, when the market is doing well, they make slightly lower returns than aggressive investors. Similarly, in case of a downturn, their losses can be considerably lower.
Just as the name implies, conservative investors are extremely cautious and have limited risk tolerance. Therefore, they avoid risky or volatile investments as they value protecting capital instead of generating profits. While they incur the least losses, their strategies also limit their profits even under attractive market conditions.
It's common for younger investors to have a high-risk tolerance. Young people can take greater risks as they have the capacity and time to make more money even if they incur significant losses in one investment. In contrast, older investors have a lower risk appetite as they need to ensure their savings are available through their retirement. Older investors also generally have more financial responsibilities and hence are likely to be more conservative.
The higher the amount of capital up for investment, the more willing an investor would be to take in more risk. More capital offers a layer of protection, allowing investors to place bold and larger trades in the market. Therefore, an investor with a portfolio running into crores of rupees will always be ready to take more risks than an individual with a portfolio with thousands.
Higher Income Stability
Investors with high stable incomes are always ready to experiment with investments as their financial position is more than secure. Therefore, they tend to have higher risk tolerance. In contrast, an investor with a low, unstable income will have a low-risk tolerance, as losing any amount could be detrimental to their financial goals.
Investors who want to accumulate significant returns over a short period will always have a higher risk tolerance. As a result, they tend to risk more in an attempt to generate greater returns. In contrast, conservative investors with a low appetite for risk will always invest cautiously and will be contended with accumulating small returns over a long period.
The best way to manage risk is to gauge one’s risk tolerance before settling on any investment opportunity. Knowing the amount of loss one can tolerate makes it much easier to make informed and calculated decisions.
While risk is a double-edged sword, it is essential to invest only what one can afford to lose. While risking more increases the prospects of earning more, it also increases the risk of incurring significant losses in a downturn.
Some other ways to manage risks are:
Every investment has its fair share of risks. Therefore, any investor should be aware of the amount of risk they can tolerate without their portfolio or capital being wiped clean. A high-risk investment offers the potential for higher returns yet it is not guaranteed.
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Disclaimer: This communication does not constitute advice relating to investing or otherwise dealing in securities and is not an offer or solicitation for the purchase or sale of any securities. Grip Invest Technologies Private Limited ("Grip", formerly known as Grip Invest Advisors Private Limited) is not registered with SEBI in any capacity and does not advise, encourage, or discourage its users to invest or not invest in any securities. Grip is solely an execution-only platform and does not guarantee or assure any return on investments made by you in any opportunities sourced by Grip and accepts no liability for consequences of any actions taken based on the information provided. Your investment is solely based on your judgement. Investments in debt securities are subject to risks. Read all the offer-related documents carefully.