What is risk appetite?
It essentially refers to the amount of variability an individual investor is willing to tolerate and whether they want to invest in securities which are notorious for swinging up and down in value.
The logic follows that if you have a high risk appetite, you’re more willing to risk losing more money for the chance of making bigger gains. Meanwhile, a low risk appetite is associated with an unwillingness to lose money. As a rule of thumb, if you have a longer time horizon you can take on more risk than if you know you’ll be needing your invested money soon. So before deciding what to invest in, it’s worth getting clear about your strategy, and therefore, your risk appetite.
KEY TAKEAWAYS
- A person's risk appetite is the amount of price movements they're willing to tolerate in their portfolio
- It's how much an individual wants to invest in securities which are notorious for swinging up and down in value
- If you have a longer time horizon you can take on more risk
- There are 3 types of risk tolerance: aggressive, moderate and conservative
What determines your risk appetite?
Risk tolerance is shaped by many factors such as age, income, investment strategy, and trading expertise, and there’s no one-size-fits-all approach. Younger investors are typically associated with more risk as they have more time to rebound from market downhill slides, whereas older investors who are within 10 years of retirement will focus on preserving capital.
Also, if you have a short-term investment strategy where quick-wins are at the heart of your strategy, a high risk appetite is likely to be more up your street. However, if you have a long-term strategy where making 7 to 10% market returns each year is the goal, for example, then you’re likely to have a lower risk appetite.
Types of risk tolerance
There are 3 levels of risk tolerance to consider, and it’s important for you to work out which risk profile is most suitable for you.
Aggressive risk tolerance
Those very comfortable with risk are considered more aggressive investors – they’re willing to put in more money and trade in more volatile securities with the overall goal of making significant returns. These investors have a solid understanding of markets, which enables them to invest in volatile assets. Those who build a lucrative career out of investing are likely to have a high risk tolerance. It requires a lot more knowledge and requires you to be on top of your investments regularly.
Moderate risk tolerance
Those with a moderate risk appetite are comfortable with risk, but within bounds. They put in a sizeable amount of money in anticipation of potentially losing some, but do not invest more than they can afford to lose.
Conservative risk tolerance
A low-risk investor is more conservative – they build their portfolio with limited volatility in order to make stable returns without losing money. They therefore focus on fixed-income investments and high-quality stocks or funds and prefer to avoid the risk of loss to taking a chance on major gains. People with this risk profile tend to be older and less wealthy than others.
It's important to note that you can fall into different categories at the same time, or throughout different stages of your life. Your financial goals will change, meaning your risk appetite will, too!