Risk appetite signifies the amount of risk you’re willing to take on in pursuit of reward.
Understanding your risk appetite is a crucial step to understanding what type of investor you want to be. Higher levels of risk are typically associated with higher levels of reward and lower levels of risk are typically associated with lower levels of reward.
Risk appetite is inherently personal and is often influenced by your financial circumstances, investment goals, time horizon and personal tolerance for risk.
Younger investors tend to have a higher risk tolerance as they often have longer to meet their financial goals, whereas older investors tend to have a lower risk tolerance as they may foresee needing to draw down on their investment in the near future and may want to minimise volatility, whilst maximising security over the short term.
It’s important not to invest beyond your means, to develop a broad set of investment goals in context to your time horizon and to analyse your attitude towards risk not just at the start of your investment journey but throughout it.
Risk itself is not a negative thing, it is often healthy to take risks. The important thing to remember is making sure the risks you’re taking are reflective of your risk appetite and your personal circumstances.
A general rule of thumb is never to invest more than you can afford to lose. No investment is ever a “sure thing” so it’s always important to ask the following question when gauging your risk appetite:
“If this investment went to $0 tomorrow, how would this impact my financial situation?”
Some other basic questions you can ask to self-assess your risk appetite include:
- What are my investment goals? E.g. investing for retirement, mortgage, lifestyle, etc.
- What is my time horizon for investing? E.g. 5 years, 10 years, 20-30 years, 50 years, etc.
- Do I think I’ll need to draw down on my investment in the near term? E.g. medical/health concerns, debt repayments, retirement, etc.
- What personal circumstances might influence my investment decisions? E.g. changes to: family structure, employment, lifestyle, etc.
Understanding your risk appetite is crucial to performing a risk assessment of potential and active investments and will help guide your short-term and long-term investment decisions.