Assessing Your Risk Appetite
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Risk is a result or outcome which is other than what is / was expected. It is the amount of money that an investor can afford to lose in the interim, in his quest for certain return on investments. It is a state of uncertainty. Read more to find out how to access your risk appetite.
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Assessing Your Risk Appetite
- 1. Assessing Your Risk Appetite An Investor Education & Awareness Initiative By Franklin Templeton Mutual Fund
- 2. Risk 1 Risk is a result or outcome which is other than what is / was expected Risk is the amount of money that an investor can afford to lose in the interim, in his quest for certain return on investments Risk is a state of uncertainty
- 3. Risk Appetite Vs. Risk Tolerance 2 Risk appetite is a broad- based description of the desired level of risk that one will take in pursuit of one’s investment goal. Risk appetite refers to willingness of an individual to take risk Risk tolerance reflects the acceptable variation in outcome related to the investment Risk tolerance implies ability of an individual to tolerate the level of downside risk Risk Appetite Risk Tolerance
- 4. • Age • Past experiences • Knowledge Determinants For Risk Appetite 3
- 5. • What is your current financial situation? • Income • Expenses • Assets • Liabilities • Financial responsibility you are shouldering • Has a contingency fund been built? • How close are you to your financial goals • Is there enough life insurance cover? • Is there enough health insurance cover? Determinants For Risk Tolerance 4
- 7. • It facilitates in prudent investment planning • It facilitate in prudent asset allocation • It can facilitate in optimising risk-return relationship for your investment portfolio. Why Recognising Risk Profile Is Important? 6
- 8. Categories Of Risk Profile 7 Aggressive Moderate Conservative
- 9. Indicative Asset Allocation 8 (Note: The asset allocation given above is purely indicative and not conclusive.) Category of Risk Profile Indicative Asset Allocation Equities (%) Debt (%) Aggressive 70 30 Moderate 50 50 Conservative Upto 20% 80%
- 10. Some Key Take Away Points! 9 • Remember, return on your investment has risks associated with them • Do not rush with investing • Ask yourself, can you afford to take risk • Know where you stand financially! • Know the financial responsibilities you are shouldering • Ideally, build a contingency fund • Know how close to you are to your financial goals
- 11. Some Key Take Away Points! 10 • Have an optimal health insurance cover • Know your age • Gauge from past experiences • Remember, Risk tolerance implies, ability to take risk • Risk appetite refers to your willingness to take risk • Prudent risk profiling can help in effective investment planning & right asset allocation • Risk profiling can optimise risk-return relationship
- 12. Lets Do A Short Quiz! 11 we now invite you to test your learning by taking up this simple quiz
- 13. 1) Risk is a result or outcome which is other than what was expected A. True B. False 2) Risk tolerance implies ability of an individual to …………… A. Generate Return B. Take Risk C. Make Investment D. Identify Asset Class 3) Which of the following is not a category of risk profile? A. Conservative B. Moderate C. Aggressive D. High Net Worth Quick Quiz 12
- 14. 4) Risk Tolerance + Risk Appetite = A. Low Risk B. Risk Profile C. High Risk D. Medium Risk 5) Risk tolerance is done taking into account which of the following: A. Income B. Expenses C. Nearness to financial goals D. All of the above Quick Quiz 13
- 15. 14 Thank You For Participating!
- 16. 15 Mutual Fund Investments Are Subject To Market Risks, Read All Scheme Related Documents Carefully.
- 17. © 2014 Franklin Templeton Investments. All rights reserved. Franklin Templeton Asset Management (India) Pvt. Ltd. Indiabulls Finance Centre, Tower 2, 12th and 13th floor, Senapati Bapat Marg, Elphinstone (W) Mumbai 400013 Tel (91-22) 6751 9100 Fax (91-22) 6639 1281 www.franklintempletonindia.com
Editor's Notes
- INTRODUCTION Any discussion on an investment avenue is incomplete unless it underlines the risk along with the potential return on it. Very often we all want to earn high returns on our investments. But high returns come at a price. There are no ‘free lunches’! You see, earning high returns also calls for taking high risk. And mind you, not all are comfortable in taking high risk. Thus before you fall for investment products which offer high returns, assessing the risk associated with that investment product in conjunction with your own risk taking ability is critical. So in today’s learning session let us tread gradually on the learning curve to recognise how to assess your risk appetite or risk profile. So first let us understand what is meant by ‘risk’?
- Risk Risk is a result or outcome which is other than what is / was expected (…so while you assume risk, you could either make gains or suffer a loss.) (So to put it bluntly…) Risk is the amount of money that an investor can afford to lose in the interim, in his quest for certain return on investments Risk is (nothing more than) a state of uncertainty (…and that exists in every facet of life)
- (Now that we have learnt the term ‘Risk’, let us see whether risk appetite and risk tolerance are same i.e. can they be interchangeably used) Risk Appetite vs.Risk Tolerance Risk appetite is a broad-based description of the desired level of risk that one will take in pursuit of one’s investment goal. Risk tolerance reflects the acceptable variation in outcome related to the investment Risk appetite refers to willingness of an individual to take risk (So you might love sky diving, bungee jumping and so on… but you must also be physically fit to participate in such activities. On similar lines, as an individual you may be a risk taker, and probably would not hesitate to put your money in risky avenues. However, it is imperative to take into consideration your present situation before taking investment decisions.) (whereas…) Risk tolerance implies ability of an individual tolerate the level of downside risk
- So let us understand what determines one’s risk appetite…) Determinants for Risk Appetite Age (…you see, your age plays a very vital role in determining your risk appetite. Usually, at a younger age one has the willingness to take high risk. This is because you are in the accumulation or earning stage of your life cycle, where you have more number of working years before you retire. But as age progresses risk appetite generally declines. This is primarily because as the investor matures in age and reaches retirement, he / she psychologically cannot tolerate high volatility in his portfolio.) Past experiences (…If someone going by past experiences, has earned substantially high returns, he / she would have the heart to take more risk. But if past experiences have been dreadful, someone would not have the heart to take more risk.) Knowledge (…This is one of those rare assets which may never lose value. A thorough knowledge about something increases your awareness. Becoming aware about good and bad effects completely, would push your risk appetite up.)
- Determinants for Risk Tolerance (To determine risk tolerance you need to ask yourself a few set of questions…) What is your current financial situation? (And to answer that you need to assess your income, expenses, assets, liabilities and financial responsibilities that you are shouldering) Income (…this is an important determinant to gauge risk tolerance. So, if your income is high enough, you will not mind taking higher risks while making investment decisions.) Expenses (…you see, your outgoings also influence the risk that you can afford to take while investing. You may have a high income, but if your disposable income is petite you could be refrained from taking high risk. Hence it is imperative for you to streamline unnecessary expenses, so as to keep your financial health in the pink.) Assets (…the quantum of assets held by you, both – moveable and immoveable too would go in determining your risk tolerance. So if you’ve built sufficient assets over time, you could have a high risk tolerance and vice-versa) Liabilities (…the amount of liabilities you have in terms of loans outstanding, would also help you assess your risk tolerance if you are cognisant about the same. So if you are overburdened with liabilities, your risk tolerance would be low.) Financial responsibility you are shouldering (…yes, you also need to ascertain this because you may be having a number of dependents in your family, where you may be catering to their life’s goals - such as children’s education, their marriage etc.) Has a contingency fund been built? (…meaning have you already saved for a rainy day that can enable you to take risk. If not, then your risk tolerance could be low; because you are not financially ready to manage any contingent events. Ideally, you should hold 6 to 12 months of your monthly expenses by setting aside some portion of your income for building a contingency fund / reserve.) How close are you to your financial goals? (…you see, if you have planned for a financial goal, the time left to achieve the goals also determines the risk that you can prudently afford to take while investing. So if you are adequately away in terms of years from meeting your financial goal, you can afford to expose your portfolio to higher risk which may enable you to create more wealth in the long term. But if your financial goal is drawing nearer say just 3 years away, then you could be a risk-averse investor to preclude wealth erosion.) Is there enough life insurance cover? (…yes, it is imperative to ask this question because, if you haven’t taken an optimal life insurance cover, and if something happens to you as a bread earner, there may not be enough financial protection / indemnification to take care of your loved ones; and in such a case the risk tolerance would be low.) Is there enough health insurance cover? (…As you may be aware, health insurance cover reimburses the hospitalisation bills in case the insured has to be hospitalised for any illness. So again, it is imperative to have an adequate health insurance recognizing the rising cost of medical treatment. And in case you do not have an adequate health insurance cover, then your risk tolerance could be lower.) (…So while you are gauging risk tolerance, you ought to ask yourself a host of such questions and answer them rightly to prudently ascertain your risk tolerance)
- Risk profile is a combination of risk tolerance and risk appetite which helps in prudent risk assessment. Once you have identified your risk tolerance and risk appetite levels well, you would be nearly close to precisely assessing your risk profile
- Why Recognising Risk Profile is Important? It facilitates in prudent investment planning (…after all your choices of investment products should be well aligned with your risk assessment, or else you may land up making incorrect investment decisions. You see, most investment disasters are fashioned when investors use the investment as a reference point and then try to mould their risk profile accordingly.) It facilitates prudent asset allocation (…this is because your hard earned money will be invested in respective asset classes such as equity, debt, gold and real estate depending upon your risk profile.) (…And following these two which we just learnt of…), It can facilitate in optimising risk-return relationship for your investment portfolio.
- Categories of Risk Profile (Based on the risk profile an individual is generally classified as…) Aggressive (…they are the ones who aim at long term capital appreciation and have goals that are a distance away…generally more than 5 years .) Moderate (…they are the ones who aim at providing some stability to their portfolio along with capital growth. They have goals with medium term horizon – about 3 to 5 years away.) Conservative (…they are the ones who prioritize the protection of their capital and are risk averse. They have life goals to be met which are less than 3 years away and therefore are not comfortable in taking risk and prefer keeping their hard earned money in safe investment instruments.)
- Some Key Take Away Points! Remember, return on your investment has risks associated with them (…there are no free lunches) (So,) Do not rush with investing (…ascertain your risk profile and undertake thoughtful research by doing a holistic study) Ask yourself, can you afford to take risk? (…this will help you decide the level of risk you can take) Know where you stand financially! Know the financial responsibilities you are shouldering Ideally, build a contingency fund (…do not forget to maintain 6 to 12 months of your expenses as your contingency fund) Know how close you are to your financial goals (…longer the time horizon to your next goal, higher can be the risk you can take)
- Some Key Take Away Points! Have an optimal health insurance cover Know your age (…the younger you are, the higher can be your risk appetite) Gauge from past experiences (…you ideally learn from your past experiences) Remember, Risk tolerance implies, ability to take risk (whereas…) Risk appetite refers to your willingness to take risk Prudent risk profiling can help in effective investment planning & right asset allocation Risk profiling can optimise risk-return relationship (…once you have done your risk profiling well, you can build a proper return expectation; which can help you choose the appropriate asset class for your investment portfolio)
- So to end todays learning exercise,