Knowledge of Risk Tolerance
Under the present market conditions, one thing has become evident. Returns on investments, like everything else, come at a price. You must be able to handle severe volatility in order to make huge gains. To put it another way, a high rate of return on investment is a reward for taking on a lot of risk. The risk-reward trade-off is a term used to describe this situation.
People often invest only on the basis of the rate of return given by investment agents and relationship managers. There are, however, a bevy of other clues that investors sometimes ignore at this point. One of the most important factors to consider is risk. We give it a lot of thinking before acquiring a smartphone. We consider the features, performance, and, of course, cost. We aim to strike a balance between the utility of cellphones and their price. Similarly, risk, along with earnings, is an important aspect in investment. Almost all investment products are risky in some way; the extent of the risk varies. As a consequence, it's vital to understand your risk tolerance level before blindly hawking financial products.
The second question is: how can we determine our risk appetite and tolerance? The bulk of investors make the mistake of mixing these two types of investments. Before making investment decisions, they are two independent notions that must be addressed individually. Risk appetite refers to your willingness to take risks, while risk tolerance refers to your ability to do so. Extreme sports may appeal to you, but you must be physically fit to participate in them. Similarly, you may be a risk taker who is not afraid to engage in high-risk initiatives as a person. However, before making any investment decisions, you must first assess your existing situation.
Investors often place bets on the market based on 'tips,' which may or may not be founded on strong financial logic or research. Because of their desire to earn alpha, they will blindly jump into investment ideas without considering their potential. This has a negative impact on their investment portfolio. You should be sceptical of offers that emphasise profits while downplaying the danger involved. So, the next time you hear or read about investing possibilities or avenues, ask yourself this simple question: "Does this investment opportunity or avenue fit my risk profile, despite the attractive returns?"
Investors with a long-term capital appreciation goal and a high risk tolerance might consider allocating a larger share of their portfolio to risk assets. The fact that they still have a broad time horizon to achieve their financial objectives will help them overcome any potential losses caused by volatility. Moderate investors may invest up to 60% in shares and the rest in debt and cash to provide some stability and capital growth to their portfolio. Conservative investors that value capital preservation and are risk averse may spend up to 70% of their portfolio in debt and cash, with the remainder diversified by investing in high-quality equity instruments.
Wrapping Up
Your risk tolerance is the foundation of your financial strategy. After you've bracketed yourself depending on your risk tolerance, it's time to get serious about preparing your financial future. Open a demat account now to start your investment journey!
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